Mortgages can be boring, confusing and generally aren’t really something people want to think about until they have to. But understanding how they work - and the different types available - can make a big difference when the time comes. So, in Simplicity style, we thought we’d explain the four main mortgage types - as simply as possible. (There are some other types but we’re keeping it simple!) 

FIXED RATE HOME LOAN

This is the most common type of home loan. You pick a loan term (usually up to 30 years, sometimes shorter) and a fixed term. Fixed means your interest rate remains the same for a selected period of time, typically ranging from six months to five yearsin New Zealand. During that time your interest rate isn’t affected by the market. Your repayments are constant and stay the same during the fixed term.

Example: You take out a home loan with a 5% fixed interest rate for 1 year. No matter what happens to market interest rates, your repayments stay the same for that 1 year period.

Pros

- Payments are regular with a set date for when the loan will be paid off.
- It offers predictability and protection if interest rates rise.

Cons

- On the flip side, if interest rates drop you won’t benefit.
- Less flexibility for people with irregular income or those wanting to pay off their loan early (early repayments can incur fees).

FLOATING RATE HOME LOAN

This type of loan is similar, but your interest rate is floating (or "variable"). When the market goes up, so does your interest rate and when the market goes down, so does your interest rate.

Example: You get a floating rate loan at 7%. After a month the market drops and so does your interest rate; now it’s 6.5%. But if the market interest rates go up again, so will your interest rate - meaning your repayments also increase.

Pros

- A floating mortgage offers more flexibility, meaning you can often make early repayments or change the loan term without penalties.
- Reap the rewards when the interest rates drop.

Cons

- But, pay the price when interest rates increase.
- In the past, floating rates have typically been higher than fixed.

REVOLVING CREDIT LOAN

This type of loan works like a huge overdraft. Your pay goes straight in, you spend from it like a normal account (up to your credit limit!), and interest is only charged on what you owe. Lenders calculate interest daily, so by keeping the balance of the loan low you can pay less interest in the long-run. You can also team up your revolving home loan with another type of home loan - like the ones described above. The interest you pay will be at the floating rate.

Example: You have a $200,000 revolving credit loan but have just been paid $5,000 so you’re only charged interest on $195,000 while the money sits there. As you spend during the month, your loan balance goes back up to say $197,000 and therefore you’re charged interest on the amount in your account every day.

Pros

- Keeping your savings in this account will give you bigger interest savings and avoid banking fees from using a separate savings account.
- Good for people with irregular and uneven income as there are no fixed repayments.
- If you’re a budgeting ninja or saving wizard, you can pay off your home loan faster and cheaper!

Cons

- For the impulsive spenders out there, this loan requires more discipline than you may naturally tend to have. You don’t want to stay in debt longer by always spending up to the credit limit.
- Typically higher interest rates as it’s floating. 

OFFSET LOAN

An offset loan also reduces the amount of interest paid on your home loan by linking your home loan to any savings or everyday accounts you have. It can be linked to multiple accounts including your children’s and your parents. The total balance of the linked accounts is used to offset the amount of interest you pay.

Example: You have an offset loan of $100,000 with a total of $20,000 in your linked accounts. You’ll only pay interest on $80,000.

Pros

- Make all your money work harder by linking family accounts - it’s the Bank of Mum & Dad 2.0.
- Typically there’s no fixed term, so you pay less interest and pay it off faster.

Cons

- Typically higher interest rates as it’s floating.
- Linked accounts do not earn interest when they’re offsetting a loan. But it's tit for tat, as you need to think about what you could save by paying less interest on your loan. Lenders don't typically offer savings interest rates at the same level as they lend money!

You don’t need to be a mortgage expert, but of course knowledge is power - it's handy to be informed, as someone who knows what’s out there. Given these are major financial decisions that could have significant consequences, we recommend you get independent, professional advice to ensure your decisions make sense for your own personal situation and goals.

And remember, even if mortgages are boring, paying less interest is never boring!

For more handy tips, tricks and information around mortgages listen to our Money Made Simple podcast all about mortgage types:

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The information provided and opinions expressed in this article are intended for general guidance only and not personalised to you. These materials do not take into account your particular financial situation or goals and are not financial advice or a recommendation. This article is not intended to convey any guarantees as to the future performance of any of the investment products, asset classes, or capital markets mentioned. Past performance is no guarantee of future performance. Information is current at the time of posting, and subject to change without notice. Simplicity NZ Ltd is the issuer of the Simplicity KiwiSaver Scheme and Investment Funds. For Product Disclosure Statements please visit our website simplicity.kiwi.