Guide to variable, fixed and offset home loans

Loan type: What type of a buyer are you?

Different loan types are tailored to buyers with different objectives. Understanding what type of buyer you are is the first step to finding the right loan.

Investor vs. owner occupier

Are you buying a home to live in or buying a home as an investment property? This can make a significant difference to the type of loan you need and the interest rate that you will pay.

Generally speaking, people buying a home will pay a slightly lower interest rate than investors because they are seen as being more likely to make their repayments.

This can also affect the type of repayments you choose, because repayments by owner occupiers and investors are treated differently by the Australian Tax Office.

What is a refinancer?

If you have a loan and want to switch to a new loan, you are a refinancer. 

There are many reasons to refinance. You might want to switch from a fixed to a variable rate, borrow extra money to renovate your property, or take out a loan with a lower interest rate.

Refinancing to a lower rate lender can potentially save you thousands, which is why you should compare your loan to the market from time to time to make sure it is still competitive.

Home loans last for decades but the market changes constantly along with your needs so it’s a good idea to make sure you still have the best product available.

What is a first home owner?

If you are buying a property for the first time, whether as an investment or to live in, you are a first home owner.

If you are going to live in the property, you may be eligible for the first home owners’ grant or a stamp duty tax exemption.

Renovator or builder?

Are you planning to buy some land and build a home on it? Do you want to do a major renovation on your own home or a newly bought property? In that case, you may want to consider a construction loan.

A construction loan will pay out money in stages as you build your home, meaning you can lock in your finance before you have a completed asset to secure it against.

Most construction loans are interest-only, and then convert to principal and interest when the property is completed.  While they are primarily designed for people building a home from scratch, some lenders will offer them to renovators as well.

What are the key milestones in a construction loan?

  • Slab
  • Frame
  • Lock up
  • Fixing
  • Completion

What are the types of interest rates?

The interest rate on your loan is the price your lender charges you to borrow the money. The price is expressed as an annual percentage or “rate.”

The price will vary depending on a number of factors including:

  • Fixed vs variable home loan rates
  • Principal and interest repayments
  • Interest only repayments
  • Your Loan to Value Ratio (LVR)
  • Whether you are buying a property to live in or as an investment

Before you choose a home loan, it’s a good idea to decide what kind of interest rate you want to pay. At any given time, some lenders will be offering specials on certain types of rates, and other lenders will be focusing on others.

In the Australian market, there are three main types of rates you can choose from:

  1. Fixed rate loan
  2. Variable rate loan
  3. Split loan

Which loan should I choose? Fixed, variable or split?

What is a fixed rate?

A fixed rate home loan means your loan repayments will be charged at the same interest rate for an agreed period, typically of 1 – 5 years. Lenders typically charge different rates for different time periods. For instance, they will have specific 2-year fixed home loan rates and 3-year fixed home loan rates.

After this time, the rate will revert to a variable home loan rate, unless you agree with your lender to fix the rate again.

What are fixed rate pros and cons?

Pros

  • You are protected from any rate increases
  • Easier to budget because you know what your rate will be

Cons

  • Typically have a slightly higher interest rate
  • You won’t save any money if rates go down
  • No offset
  • More expensive to refinance – usually incur a break fee

VIEW FIXED RATES

What is a variable rate?

With a variable home loan, your lender can vary the interest rate at their discretion. This will usually happen in response to a change in the lender’s cost of funds. That could happen for many reasons, including a change in the Reserve Bank of Australia’s official cash rate. This means your repayments will go up and down.

What are variable rate pros and cons?

Pros

  • Typically have a lower interest rate
  • Potential to pay less if rates fall
  • More features like unlimited repayments
  • Less cost to refinance
  • Redraw offset facility available

Cons

  • Costs you more if rates go up
  • Harder to budget

HINT: If you are considering a fixed rate loan, be sure to ask what variable rate the loan will revert to when the fixed term expires. Make sure it is a competitive rate.

VIEW VARIABLE RATES

What is a split loan?

A split loan means that a portion of the loan is subject to fixed home loan rates and a portion is subject to a variable interest rate. For instance, you might fix 50 per cent of the loan, and leave 50 per cent variable. This means that if rates go up, your repayment will only increase on the variable portion, while the other half will remain the same. A split loan is a compromise between the pros and cons of fixed and variable interest rate loans.

What are split loan pros and cons?

Pros

  • If rates rise, you will only pay more on the variable portion
  • You still retain the flexible options of a variable rate loan including an offset and extra repayments

Cons

  • If rates fall, you only get a reduced rate on the variable portion
  • You will incur break frees if you refinance during the fixed term

Principal & Interest vs Interest Only

With any loan, you will ultimately need to pay back the amount you borrowed (the principal) plus any interest charged.

When you do this in equal instalments through the loan, this is called “principal and interest” repayments.

However, many lenders including loans.com.au will give you the option of making ‘interest only’ payments for a limited amount of time.

This means that during the agreed interest-only period, you are only paying the interest on the loan and not repaying the principal.

This will have the effect of lowering your repayments during the “interest-only” period.

However, you will still need to repay the outstanding amount before the loan terms ends, which means your repayments during the remainder of the term will actually be higher.

The total amount of interest you pay will also be higher because the balance outstanding will be higher for longer.

On the flip-side, if you are paying down the principal on your loan with principal and interest repayments, your monthly repayments will start higher but you will pay off your loan faster.

What are principal and interest pros and cons?

Pros

  • Pay off your loan faster
  • Less total interest on the loan

Cons

  • Repayment will be higher than interest only

What are interest-only pros and cons?

Pros

  • Lower repayments during the interest-only period

Cons

  • Higher repayments when the interest-only period ends
  • More interest in total over the life of the loan

What is a redraw offset facility?

What is an offset?

Some lenders offer a mortgage offset account and others offer a redraw offset facility. Either way, having an offset home loan lets you pay off your loan faster and with less interest.

Whenever you put money into an offset account or redraw offset facility, that money is 100% "offset" against your home loan.

So, if you had a loan of $400,000, and $5,000 in your offset, you would only pay interest on $395,000.

Your monthly repayments won’t change but you will pay more off your home loan principal each month, so you will pay off your loan faster and with less total interest.

Best of all, whenever you need the money back, you can withdraw it at no charge. For this reason, many people choose to use their offset as their transaction account, and have their pay put into it each month, then progressively draw it down as they spend it.

What are offset pros and cons?

Pros

  • Pay off your loan faster and with less total interest
  • Use the redraw offset facility as a fully featured transaction account

Cons

  • Pay a small interest premium compared to a loan with no redraw offset facility

VIEW OFFSET PRODUCTS

Recommended reading

Everything you need to know about mortgages

It is very important to understand mortgage before choosing the home loan that is right for you. Here you can find out how mortgage works.

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Mortgage rates in Australia

Here are some important terms you will encounter that are related to the mortgage rate and repayments on a home loan.

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Understanding equity in your home

Equity is an important asset for every homeowner as it can be beneficial in many ways. You may be able to use your equity to improve your lifestyle.

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