Different types of mortgages and how they work

Table loan

This is the most common type of home loan. You can choose a term up to 30 years with most lenders. Most of the early repayments pay off the interest, while most of the later payments pay off the principal (the initial amount you borrowed).

You can take a table loan with a fixed rate of interest or a floating rate.

Application fees for table loans range from nothing to over $1,000. Most lenders charge around $200 to $400. This is often negotiable.

Advantages:

Table loans provide the discipline of regular payments and a set date when they will be paid off.
They offer the certainty of knowing what your payments will be, unless you have a floating rate, in which case repayment amounts can change.

Disadvantages:

Fixed regular payments might be difficult for people with irregular income.

Revolving credit loan

Revolving credit loans work like a giant overdraft. Your pay goes straight into the account and bills are paid out of the account when they’re due. By keeping the loan as low as possible at any time, you pay less interest because lenders calculate interest daily.

You can make lump-sum repayments and redraw money up to your limit. Some revolving credit mortgages gradually reduce the credit limit to help you pay off the mortgage.

Application fees on revolving credit home loans can be up to $500. There can be a fee for the day-to-day banking transactions you do through the account.

Advantages:

If you're well organised, you can pay off your mortgage faster. This also suits people with uneven income as there are no fixed repayments.
Putting surplus funds into this account rather than a separate savings account will give bigger interest savings and also avoids the tax on the savings account interest.

Disadvantages:

It needs discipline! It can be tempting to always spend up to the credit limit and stay in debt longer.

Offset loan

An offset mortgage setup can reduce the amount of interest you pay on your mortgage. Typically, interest is payable on the full amount of a loan. But by linking your loan to any savings or everyday accounts you already have, you pay interest on that much less. For example, someone with a $400,000 mortgage and $20,000 in savings would only pay interest on $380,000. Subtract the savings from the total loan amount, and you only pay interest on what’s left.

The more cash you keep across your accounts from day to day, the more you’ll save, because interest is calculated daily. Linking as many accounts as possible – whether from a partner, parents, or other family members – means even less interest to pay.

Advantage:

You pay less in interest and pay off your mortgage faster. Typically there is no fixed term.

Disadvantage:

The linked savings accounts do not earn any interest when they offset a loan. That said, interest on debt is typically higher than the interest you would earn on savings, which makes the offset worthwhile.

Reducing loan

Reducing or straight line mortgages repay the same amount of principal with each repayment, but a reducing amount of interest each time. These are quite rare in New Zealand. Payments start high, but reduce (in a straight line) over time. Fees are similar to table loans.

Advantages:

We pay less interest overall than with a table loan because early payments include a higher repayment of principal.
These may suit borrowers who expect their income to drop, for example, if one partner plans to give up work in a few years’ time.

Disadvantages:

If we can manage higher payments, it would be better to take a table loan with payments high for the whole term, so we pay less interest.

Interest-only

We pay the interest-only part of our repayments, not the principal, so the payments are lower. Some borrowers take an interest-only loan for a year or two and then switch to a table loan. The normal table loan application fees apply.

Advantages:

We have more cash for other things, such as renovations.

Disadvantages:

Ultimately it costs us more. We will still owe the full amount that we borrowed until the interest-only period ends and we start paying back the loan.

Interest rate: fixed, variable or both?

Fixed interest rate loans

With a fixed rate home loan the interest rate you pay is fixed for a period of six months to five years. At the end of the term, you can choose to re-fix again for a new term or move to a floating rate.

Advantages:

You know exactly how much each repayment will be over the term.
Lenders often compete with fixed rate specials.
You can lock in lower rates if market interest rates are rising.

Disadvantages:

Fixed rates often have limits on how much you can raise repayments or make extra payments without paying charges.
If you take a long term, there is a risk floating rates may drop below your fixed rate.
If you choose to sell your property and/or break a fixed loan you may be charged a ‘break fee’.

Capped rates are a variation where the interest rate can’t rise above a certain point, but will drop if floating rates drop below the capped rate.

Floating rate (or variable rate)

Lenders of floating rate loans will lift or lower the interest rate as interest rates in the wider market change, normally linked to the Official Cash Rate (OCR). This means your repayments may go up or down.

Advantages:

You have more flexibility to make changes without penalty, such as paying off the loan early or changing the loan term.
It’s easier to consolidate other, more expensive debt into floating rate loans by borrowing more.

Disadvantages:

Floating rates have historically been higher than fixed rates.
When rates go up the repayments also go up, putting a squeeze on your budget.

A mix of fixed and floating

You can split a loan between fixed and floating rates. This lets you make extra repayments without charge on the floating rate portion.

Splitting a loan can give you a balance between the certainty of a fixed rate and the flexibility of a floating rate. How much of your loan you have in each portion depends on which of these is more important to you.