The different types of debt

Home Loan

A home loan is a loan that is taken out to purchase property using the property as collateral for the loan (more on that later). A home loan allows you to purchase a property without having to pay the full amount upfront; and what you pay upfront depends on the lender’s policy and fees and charges. You can get a home loan for either a live in or investment property. You then make regular repayments (usually once a month) to pay off the home loan for an agreed upon term (usually between 15 to 30 years); your home loan repayments will be made up of both principal and interest, unless you opt in for an interest only period on your home loan (this depends on whether your lender offers interest only products). If you stop making your home loan repayments, the lender may begin the foreclosure process, which would mean seizing your property (this is what we meant by ‘collateral’ earlier) and selling it to recover the cost of your home loan.

Personal Loans

Personal loans can be used for a number of different reasons and are typically used to pay for big ticket purchases that you may not have the money for upfront. Like a home loan, personal loans have associated interest and fees associated that you will also need to pay.

Some of the things you can get a personal loan for include:

• Renovations
• Furniture and whitegoods
• Purchasing a car
• Holidays
• Weddings
• Debt consolidation

Unsecured personal loans don’t require you to use any assets as collateral, while secured personal loans will require an asset as security (usually a property or vehicle). Using an asset as security means that the lender can take possession of that asset to cover the remaining cost of your loan should you stop making repayments, but interest rates for secured loans and generally lower than those for unsecured loans.

Credit Cards

Credit cards are revolving debt, which means that you don’t have a set period of time that you need to pay it off. Instead they have a credit limit, and once you reach that credit limit you can’t borrow anymore money until you pay some of it off. This means that credit cards can be used indefinitely unless you cancel the account. Keep in mind though that credit card interest is usually calculated daily on the amount owing on the card, so every day that you owe money on your credit card you’ll be paying interest on that amount. Each month you’ll get a bill with the total amount of interest, and any fees associated with having the credit card, added to the amount you owe, so having one can become quite costly. It’s also important to note that when assessing you financial situation, lenders will count your credit card limit towards your total amount of debt, not just the amount you currently owe.

Buy Now Pay Later

Buy now pay later (BNPL) services allow you to purchase items on the spot, and then pay for them in instalments. Some BNPL services will require you to pay of the item in a set amount of time, but others let you have a spending limit with a minimum monthly repayment. You don’t need to pay interest on BNPL services but you will be charged a fee if you are late on your repayments. Some BNPL services also charge other fees e.g. payment processing/account-keeping, so it’s important to do your research before using them.

There are now lots of different BNPL services including:

• Afterpay
• Zip Pay
• Zip Money
• Openpay
• Splitit
• Klarna
• Humm
• Brighte

And the list goes on!

To find out how BNPL services can affect your home loan application, check out our Home Loan Guide here.

Interest-free deals

Interest-free deals allow you to put the cost of a purchase onto a store card or credit card instead of paying for it upfront. You then pay off either in instalments or in a lump sum at the end of the interest-free period. At the end of that period you will be charged interest on any amount that remains on the card.

Interest-free deals help you make larger purchases that you may not have the upfront money for, but they can still have fees attached to them. On top of this, not fully repaying what you owe will see you paying interest until you are able to pay it off.

You might even come across deals that are interest free indefinitely, these can seem like a better option but make sure you check for other costs, like fees, that could be attached to the deal. Before getting any interest-free deal it’s a good idea to check the terms and conditions so you know what additional costs you could be up for.

Consumer lease

A consumer lease allows you to rent items (TV’s, fridges, washing machines, laptops etc.) for a period of time. During this time you make rental payments until the lease ends. At the end of the lease you will usually have a few options; depending on the terms of your lease, you can either continue leasing the item, return the item, offer to buy the item, or upgrade to a better/newer model with a new lease. It’s important to note that at the end of a consumer lease, you don’t automatically own an item.

Rent-to-buy

Items

Another way you can get big ticket items is with a rent-to-buy arrangement. Rent-to-buy arrangements are a type of lease where you have the option to take ownership of the item at the end of your lease term. While they can be a handy way to get the item you want or need sooner rather than later, rent-to-buy leases can end up being a very expensive way to buy your items. Often you will end up paying well over the retail price of the item you are leasing. It’s also important to note that you don’t legally own the item until you have purchased it at the end of the rent-to-buy agreement.

Houses

Another item you can rent-to-buy is a house. Like other rent-to-buy arrangements, you agree with the seller to rent the property for a set period of time, and at the end of that period you can purchase the property for an agreed amount. The rent you pay goes towards paying this amount (as well as other expenses), essentially helping you to gain ‘equity’, then once the renting period is over you pay the remainder of the sale price. Again, it’s always a good idea to get professional financial advice before entering into this sort of arrangement.

Payday loans

Payday loans are short-term loans used to borrow small amounts (usually up to $5,000) to provide the money you need until your next pay cheque. They’re designed to be paid off quickly, usually between 2 weeks to a year. Payday loans can be a costly way to get the money that you need; they often come with a lot of fees, and can see you paying way more than the amount you borrowed.

Margin lending loans

Margin loans are a type of investment loan used to borrow money so you can invest in things like shares and managed funds. A margin loan is secured against your existing shares and managed funds, kind of like the way a home loan is secured against your property. Margin loans can be a great way to expand your investment portfolio, but do come with risk – as in, if your investment does poorly, you’ll still need to repay the loan.

Other types of consumer loans

HECS/HELP debt

HECS/HELP debts can be used when you attend university or other approved higher education providers to help you with various aspects of your studies. They don’t cover things like accommodation, books, laptops, supplies, parking etc. You can learn more about HECS/HELP debt here.

Personal overdrafts

A personal overdraft is a line of credit that is linked to your transaction bank account. It kicks in whenever your bank account drops below zero, so if you’ve ever seen your account in a negative balance that’s your personal overdraft. It can be a handy feature to have on your transaction account, but you do need to pay interest on the amount you use. You should check the interest rate applied to overdraft amounts too as they vary from lender to lender (and some can be quite high). For example, your account goes into -$50.00 balance, you’ll need to pay interest on that $50.00 until your account is in the positive again.

Personal lines of credit

With a personal line of credit you have a credit limit that you can borrow for a set period of time, this is known as a draw period. During your draw period you can draw out money from your available balance (up to your credit limit) as you need it, kind of like a credit card. You start paying interest once you withdraw your first amount, but only pay interest on the amount you’ve withdrawn, not on the full amount. Much like a credit card, you will then make monthly repayments to pay back what the amount withdrawn. Personal lines of credit offer you a bit more flexibility than traditional loans as you can withdraw and pay back funds repeatedly over your draw period.

Hire purchases

A hire purchase is kind of like a rent-to-buy agreement but for business vehicles and equipment. You hire the goods you need for a set period of time and pay an agreed monthly payment, and at the end of the period you can purchase the goods and ownership is transferred to you.

Chattel mortgage

A chattel mortgage is like a secured car loan but for business assets. Like a secured car loan, your loan provider will give you the funds to purchase a work vehicle and your loan is then secured against the vehicle you purchased. Unlike a hire purchase or lease, a chattel mortgage allows you to own the vehicle straight away.