Key types of home loans
To help you understand which type of home loan may be best suited to your needs, let’s take a look at the key types of home loans available and how they work.
There are hundreds of different home loans out there in the mortgage marketplace. But fundamentally, they are all based on two key things:
- Principal – the amount of money you borrow
- Interest – how much you pay to borrow the money. It’s calculated on the outstanding principal
From here, there is a wide variety of home loan features and structures to choose from, and it’s worth knowing what’s involved with each to make an informed decision.
This is the most popular type of home loan in Australia. The interest rate you pay may vary in line with movements in market interest rates, so you can expect the repayments to vary (up and down) over the course of the home loan.
With this type of home loan the rate you pay – and the home loan repayments, are fixed for a set period, usually between one and five years. This makes it easier to budget for repayments and you are protected from increases in market interest rates. The downside is that if rates fall, you could end up paying more than necessary.
Many lenders will let you fix one part of your home loan, while the remaining portion has a variable rate. This can give you the best of both worlds – some protection from rising rates though still with the ability to benefit from any rate cuts.
Decision: fixed, variable or split loan?
To help you decide which home loan would be right for you, we’ve outlined the pros and cons of fixed, variable and split home loan types below:
|The interest rate is fixed for the term you choose – usually from 1 - 5 years. The fixed may be higher or lower than the prevailing variable at the time of fixing. The rate you pay will also vary depending on the fixed term you select.||The interest rate may vary in line with the official cash rate plus other factors, and it may be higher or lower than fixed rates.||One part of your home loan will be fixed and the other can fluctuate with the market.|
|Your repayments will stay the same for the ‘fixed’ period of the home loan.||Your repayments may fluctuate with interest rate changes. This could be up or down so you need to be sure your finances could cope with a higher rate.||Interest rates can go up and affect the variable part of your home loan.|
|Fixed repayments make it easier to budget though you may have fewer opportunities to pay more off your home loan.||You could pay off your home loan faster by making extra repayments.||Allows you to have interest rate security with repayment flexibility.|
|If you want to switch back to a variable rate or refinance to a new home loan during the fixed term, you could be asked to pay ‘break charges’.||Exit fees have been banned on home home loans taken out after 1 July 2011.||Most lenders will let you set the fixed/variable portions in the way that suits you.|
|Some – but not all, fixed rate home loans allow extra repayments up to a set amount each year, and some also offer redraw.||You can usually make extra payments whenever you like, typically at no extra charge.||You can access variable home loan features like redraws and extra payments but have a little more certainty around your long-term budget.|
Other types of loans
Within the categories of variable, fixed and split home loans, there are other types of home loans to choose from.
Basic versus standard
‘Basic’ home loans are variable rate home loans that often come with a cheaper rate though less features than a ‘standard’ home loan. The definition of ‘basic’ varies widely between lenders so it’s worth checking carefully which features are available with any home loan the lender describes as basic.
The important thing is to only pay for home loan features you are likely to use now or in the near future. Note too, some features can help you pay off the home loan sooner, and this will mean saving money over time so the cheapest loan isn’t necessarily the one that’s best for you.
An offset home loan involves a savings or transaction account that is linked to your home loan. Instead of receiving interest on the balance of the offset account and paying separate interest on the full balance of the outstanding home loan, the balance of the offset account is deducted from (or ‘offset’ against) the value of the home loan for the purpose of calculating interest.
For instance if you have $20,000 in the offset account and the value of the home loan is $350,000, you will only pay interest on a home loan value of $330,000. This can make an offset account a real money saver if you have some spare cash.
A package home loan, sometimes called an ‘ongoing discount’ home loan, combines a home loan with other financial products – usually a transaction account and/or credit card.
You can expect fee waivers on some or all of the bundled products plus a discount on the home loan interest rate that usually lasts for the life of the home loan. On the downside, you may be asked to pay an annual package fee. This makes it important to weigh up whether the fee savings and rate discount are worth more than the annual package fee.
This type of home loan allows you to draw from a fixed amount at any time, to pay for whatever you want – which could be shares, renovations, or even a holiday.
It’s like having a credit card with a big limit, but your home still acts as security for the home loan. You only pay interest on the funds you use, but you need strong financial discipline to ensure you pay off the principal as well as the interest.
These are home loans designed for self-employed people who don’t have all the financial documents providing proof of income normally required to secure a home loan. A low-doc loan can be either fixed or variable though the rate is generally higher than for a standard variable or fixed home loan, but it may be reduced after a few years if your repayments are on time. In previous years low doc home loans were offered by a large number of lenders but these days many lenders treat self-employed borrowers in much the same way as traditional borrowers often offering access to the same home loans as long as good records (like tax returns) can be provided for personal income.
Navigating a path through the mortgage maze can seem confusing – especially with so much choice available. So it’s good to know that your Aussie Broker can streamline the process for you. We listen to your needs, then - using unique software, we compare hundreds of home loans to find the deal that’s right for you.