Fixed Rate Loan & Variable Rate
A fixed interest rate is a loan structure that essentially “fixes” an interest rate for a pre-determined period of time. This, along with variable rate loans, are the standard loan structures that the most Australians have against their own homes. Generally these rates are fixed for a period of usually 1, 2, 3 or 5 years and are attractive to those that feel that the rates are due to increase in the foreseeable future. Traditionally not as popular as the variable rate mortgage, this market share has seen a dramatic increase since the GFC as borrowers try to lock in the low rates now offered. This has meant many Australians are reconsidering their current mortgage structure as rates are close to unprecedented levels with 2 year fixed rates at 4.99% and 5 year fixed rates as low as 5.61%. The variable rate loan is similar to the fixed rates with the fundamental difference that the rates are not fixed by the mortgage providers. As a general guide, the rate will move in much the same fashion and direction of the RBA rate however you will find that the banks will generally not pass on the entire rate cut to the consumer.
Interest Only Loan
This is essentially a loan where the principle loan is not repaid and only the interest is paid on an ongoing basis. This type of structure is attractive to those looking at investing in property but still have a large mortgage on their own home. The two major reasons that property investors will structure the investment in this manner is that all repayments on the loan to the investment property are tax deductible, whereas the loan on their own home is not and the investor is looking to realise some capital growth on the investment property.
Limited Recourse Loan
This is a loan that is available in most instances for those wanting to purchase a property through their superannuation. This is done through an established a Self-Managed Super Fund and is facilitated through a Corporate Trustee and held in a structure called a Bare Trust. This can be another suitable way of investing in the property market depending on your particular circumstances.
So what is the right structure for you?
There are several factors that will determine how you should structure your debt, including one’s opinion on the economy and RBA interest rate. At this stage, the current world economy outlook is pessimistic and there is an ever greater likelihood of an increase in Australia’s debt which leads to many predicting more cuts in the RBA interest rate. This generally means the banks will be passing on these cuts to the individual so it would be a suitable time to review any current and future debts and mortgages.
Ultimately your decision should be based on what you are trying to achieve out of the loan. Are you trying to manage your cash flow? Then the fixed rate might be suitable. Are you looking to increase your tax deductions through investing? Then an interest only loan might be the correct option. Or are you looking to invest through your superannuation? Then it would be the limited recourse loan. Finally, it may be that you are unsure which way the rates are moving meaning it may be prudent to implement a hybrid loan structure meaning a portion of the loan is fixed and a portion is variable.
It is important to speak to a financial adviser who can assist you in structuring your debt to ensure it is the most cost and tax effective structure. This is not only important to ensure that you save money but have a clear and concise plan for your debt structure now and into the future.
There are a lot of considerations and it is important that you take into account both the result you wish to achieve through borrowing and the impact this debt may on your overall financial position. As a minimum, once you have established your debt structure, it is suggested that individuals should review their mortgages every 2 to 3 years to ensure their rates are competitive.
Duncan Brown
Private Client Adviser
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