Understanding different types of home loans in Australia

With so many different home loan options out there to choose from, it can be overwhelming trying to pick the right one that’ll suit your needs.

Instead of searching the internet to find endless information on all the types of home loans out there, here is an easy list that goes through all the loan choices you have at your fingertips.

The different types of home loans you can choose from

What is an owner occupier loan?

As the name implies, an owner occupier home loan is for borrowers that have the intention of living in the property they purchase.

Owner occupied home loans typically have lower interest rates than investment loans as the occupants are deemed less ‘risky’ than an investor and are more likely to hang onto the property.

With an owner occupier loan, make sure to see what terms and conditions your bank or lender may have e.g. some restrict you from renting out the property for a period of time.

What are owner occupier loan pros and cons?

Pros

• Wider range of loan products available compared to investment loans
• Generally lowers interest rates compare to investment loans

Cons

• Must be living in the property for it to be classified as Owner Occupied
• Have to notify lender when you move out (less flexible)

What is an investment loan?

If you plan to rent out a property to tenants or flip it, this is known as an investment.

Investment loans tend to have higher interest rates compared to owner occupied loans. This is because investors are considered ‘riskier’ borrowers than those buying a property to reside in.

According to the Australian Tax Office, taking out an investment loan can have its benefits as interest payments can be claimed as a tax deduction.

What are investment loan pros and cons?

Pros

• You can earn rental income from having tenants rent out your investment property, if positively geared
• The interest on an investment home loan is tax deductible

Cons

• Higher interest rates
• Capital risk - the value of your investment property can decrease

What is a fixed home loan?

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 and repayments 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 if the fixed term is broken early

View fixed rates

What is a variable home loan?

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 can go up and down depending on whether your lender passes any changes onto you.

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
• Offset sub-account 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 fixed 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
• You can still qualify for an offset sub-account

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

What is a construction loan?

A construction loan is a mortgage you take out when building a brand new home or extensively renovating your current home. The major difference between a construction loan and a regular home loan is the construction loan covers expenses throughout the building process as they occur. Each stage is paid seperately to the builder at the time that stage is complete, known as progress payments. This is generally a five stage process which includes:

• Slab - completion of the slab or base
• Frame - completion of house frame with approval
• Lock up - roofing, brickwork, doors, windows
• Fixing - relevant fit outs including kitchen, cupboards, bathroom, appliances, flooring, etc.
• Completion - site cleanup, fencing, and final payment

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 construction loan pros and cons?

Pros

• Provides you protection as the builders are only being paid for the specific work they have done during every stage
• You are only charged interest on the amount used and not the entire approved loan amount, until construction is complete

Cons

• If you apply as an owner-builder, the deposit can be higher than a standard mortgage
• Most construction loans can have higher interest rates than a standard mortgage, however, if you are considering an environmentally conscious home you can receive a discounted home loan rate with a Green Home Loan

What is a line of credit loan?

A line of credit loan is a flexible loan that is very similar to a credit card (except with much lower rates) in that it offers you a certain amount of funds (set by the lender) that you can use when and how you wish. It can be repaid immediately or over a certain period of time that is negotiated with the lender.

As with a loan, a line of credit will charge you interest as soon as money is borrowed. To be considered for this type of loan, your lender will often check your credit rating and your ongoing relationship with them. You may also need to supply your proof of identity, regular income, savings, and a list of your assets and liabilities.

If you think a line of credit loan may be right for you, here are some of the things you can use it for:

• Renovations
• Buying a car
• Going on a holiday
• Weddings

What are line of credit loan pros and cons?

Pros

• You are able to draw funds whenever needed up to your approved limit. This also means you do not need to apply for a loan each time you borrow money
• You are only charged interest on what you use
• It can be a financial safety net if you ever find yourself in a position to borrow money for an emergency

Cons

• Typically higher interest rates than a standard loan
• You could receive penalties if you do not abide by the loan terms

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. Interest only repayments are a more common option for investors.

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 loan term, once switched back to principal and interest payments, 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
• Your home builds equity - can use that equity to invest

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 an offset sub-account?

Some lenders call it a mortgage offset account, while others call it an offset sub-account. Either way, having an home loan with an offset facility lets you pay off your loan faster and with less interest.

Whenever you put money into an offset sub-account, that money is 100% "offset" against your home loan.

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

Your monthly principal and interest 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 sub-account 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 sub-account pros and cons?

Pros

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

Cons

• Pay a small interest premium compared to a loan with no offset sub-account

View loans with offset sub-accounts here

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 an important step to finding the right loan for you.

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 to live in 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.

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

If you’re ready to take the property plunge, check out our competitive home loans or chat to one of our lending specialists to help you get into the property market.

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