When you as an investor are securing a loan for your business to purchase some commercial properties, interest rates are a critical factor that you shouldn’t treat casually. A small change in the interest rates matters as it will determine the amount payable during the loan payment period.
In Australia, the Reserve Bank of Australia will set the cash rate that fluctuates from time to time. Afterwards, loan lenders will set their interest rates at rates above or below the cash rate. Lenders can choose to have different interest rates depending on conditions with which the loan is disbursed.
However, the cash rate remains the most important variable in setting the rates since if it changes the other rates changes.
Types of interest rates
Variable interest rate
It is usually an interest rate that readily responds to the cash rate. Therefore, if the cash rate that RBA sets go up, the interest rate will go up but if the cash rate goes down, the interest rate will probably decline.
Variable rates are advantageous when the cash rate reduces the amount of interest to pay will be minimal. It has no restrictions making it flexible to pay extra repayments and access additional amounts that can pay-off the loan.
However, variable rates can be detrimental when the cash rate is raised, as an investor you will have to pay more for the interest. There are also cases where the interest rate payable tends to increase despite no change in the cash rate.
A wise borrower usually secures a loan at a variable rate instead of the fixed rate when confident that the cash rates will decline. When the RBA cash rate falls, the borrower will be guaranteed cheaper payments.
When any borrower chooses a fixed interest payment, it will mean that the borrower will have to pay a constant interest amount for a defined period. It provides a good safeguard against unnecessary interest rates increases in future as the rates of the loan will remain locked for around 1 to 5 years.
The good thing is that the payments for the loan will remain the same for the borrower regardless of whether the cash rate that the RBA sets changes. It will go a long way to help you as a borrower to plan for finances to make repayment amicably as there is the certainty.
However, a borrower will not be able to enjoy declining interest rates since fixed interest rates are not as flexible as variable rates. As a consequence, one cannot draw down or payoff extra repayments over time. When the interest rates fall, large amounts can be payable at the initial period of the fixed rate.
Partially fixed rate
For borrowers who are not confident with the extremes, there is a partially fixed rate which combines both variable and fixed segments of the loan. For instance, a borrower may pay $ 300000 on a variable rate and $ 200000 on a fixed rate for a loan that is $500000.
A split loan is also suitable for borrowers that need to benefit from the interest rates decline as well as the guarantee of having regular payments. It also doesn’t restrict borrowers from making additional payments as long as it is targeted to the variable portion of the loan.
However, if you compare it with a variable rate loan, split loan provides the borrower with less flexibility. Such a scenario is true as on the variable part of the loan benefits from a low interest that results from a decline in the interest rates. In case a borrower needs to refinance or pay out the fixed rate part, a significant break fee will have to be paid.
Introductory interest rates
So as credit lenders to attract newbie credit lenders, they offer low rates that seem nice to the borrowers. Such ‘honeymoon rates’ will normally apply to the initial 1 or 2 years of the loan period.
However, investors should approach with caution when seeking for loans that contain ‘honeymoon’ rates. Sometimes such a deal can lure you into nasty repayments plans that may seem cumbersome to repay.
Remember that lower rates are not an indication of the best value you will receive from a loan, charges, and fees usually escalate the loan’s cost.
Effects of loan to value on interest rates
A loan value ratio significantly influences the interest rates rate payable. A borrower can compute LVR by dividing the loan amount by the property purchase price. In essence, a lender will have less risk when the LVR is lower while bearing a higher risk when the LRV is higher.
To counter this situation lenders usually apply higher rates when the LVR is above 80%. So as a borrower, make sure you calculate the LVR to know how it affects the loan repayment. When you realize that the loan has an LVR above 80%, you could seek a lender’s insurance facility for the loan.
One can understand most charges and any fees through comparison rates that combine it with interest rates. However, the loan cost is not the sole thing that a borrower should consider when sourcing for a loan, one should also talk with the credit provider to check the offer that seems appropriate for a particular business.
Essential features in any commercial rate loan
Any business person that is searching for a loan for a particular commercial investment should consider some of these beneficial features;
- Fixed and variable interest rates: one ought to consider whether to go for a fixed or variable rate or a combination of both.
- Loan terms: check the duration that you are supposed to service the loan. Some loans can be short from 1-3 years while others long for about 10-12 years.
- Loan purpose: when comparing the loan rates, put into mind the investment or business purchases the loan is to be utilized.
- Security: it is good to appreciate that a commercial loan can be secured using a residential or commercial property. There are times that the lender will have security in the form of business asset or director’s guarantee.
- Additional redraw and repayments: when the fees that are supposed to be paid are far beyond the agreed repayment amount, it may be allowable to make an additional payment. It is also wise to examine possible draws and redraws on variable interest loans to reduce the principal amount.