Types of home loans

With hundreds of different home loans on the market, picking the right one can be confusing. So, let’s take a look at your main options and how they work.

Home loans generally have two parts: 

• Principal –the amount of money you borrow
• Interest –how much you pay to borrow the money.

Some loans are made up of principal and interest, often called P&I loans. Others are interest only loans. 

There are lots of different features and loan structures you can choose from. Here are some of the popular options. 

Variable rate home loans

The interest rate you will have to pay on a variable rate loan depends on the RBA official cash rate, changes to market interest rates or changes made by the lender. 

Fixed rate home loans

With a fixed loan, the interest rate and repayments are set. It can be a good choice if you want to know exactly how much you need to pay off each fortnight or month. People often choose this option if they think interest rates are going up. This is because the amount you pay is locked in for the term of the loan, which is usually between 1 and 5 years. But you might end up paying more if rates go down .

Split home loans

In a split loan, part of your mortgage is fixed and part of it is variable. So, you’ve got some protection from rising rates but you still benefit if rates drop. It’s like the best of both worlds. This type of loan may be right for first home buyers who are getting themselves 

Pros and cons of fixed, variable and split 

Let’s take a look at the pros and cons of the different options to help you decide which one’s right for you. 

Interest rate

• Fixed rates - The interest rate is fixed for up to 5 years. It may be higher or lower than the variable rate when you fix it.
• Variable rates - The interest rate goes up and down with the cash rate. Other factors also influence it. The rate can be higher or lower than fixed rates.
• Split - One part of your home loan is fixed and the other part is variable. 

Repayments

• Fixed rates - Repayments are the same for the period of the fixed term. You always know how much your repayments will be. But you can’t always pay off your loan when you want.
• Variable rates - Repayments go up or down when interest rates change. You can pay off your loan faster with extra repayments.
• Split - You can end up paying more when rates rise. Gives you certainty and flexibility at the same time.

Fees

• Fixed rates - You might pay a fee if you switch to a variable rate or refinance.
• Variable rates - No more exit fees on home loans taken out after 1 July 2011.
• Split - Set the fixed and variable component to suit you. 

Extra repayments

• Fixed rates - Some fixed loans let you make extra repayments each year. Others have redraw facilities. You can usually make extra payments whenever you want.
• Variable rates - You can usually make extra payments whenever you want.
• Split - Often come with redraw facilities and let your make extra payments. Gives you some certainty with repayments.

Other options

There are plenty of options within variable, fixed and split home loans.

Basic versus standard

Basic home loans are cheaper than a standard loan because they have fewer features. They also usually have a variable rate. But ‘basic’ means different things to different lenders so make sure you understand what you’re getting.

Offset

An offset facility is a savings or transaction account linked to your home loan. The balance of the offset account is deducted from your main loan when the bank works out your interest. Let’s say you have $20,000 in your offset account and the amount you owe on your home loan is $350,000. With an offset account you only pay interest on $330,000. So, you pay less interest over time.

Packaged loan

A package or ongoing discount home loan bundles a home loan with other financial products like a transaction account or credit card.

Banks will generally offer a discount on your home loan and waive or reduce the fees on some or all of the other products for the life of the loan. But you might need to pay an annual package fee. So weigh up the savings and discounts against any fees to work out whether this is the right choice.

Line of credit

A line of credit is like a credit card with a big limit. You can use it at any time to pay for things like shares, renovations or a holiday. Your home secures it and you only pay interest on the funds you use. 

Low-doc loans

These are popular with self-employed people or borrowers who might not have been in their job for long. A low-doc loan can be fixed or variable. But the rate is usually higher than a standard variable or fixed home loan.

Keep learning