Compare types of home loans
Comparing different types of loans can be overwhelming - this guide can help clear up their differences
With thousands of different home loans on offer, you’d be forgiven for thinking that it’s too complicated to figure out. But fear not, we’re here to cut through the clutter. If you’re a first home buyer, just keep in mind that all loans are based on two key things:
- Principal: the amount of money you borrowed
- Interest: how much the lender charges you to borrow the money, which is regularly recalculated based on how much you still owe.
If you’re overwhelmed by options, an Aussie Broker can help you sort through thousands of loans to find home loan options that suit your needs.
Repayment types: Principal & interest vs interest only
When choosing a home loan, you have a choice between Principal and Interest (P&I) or Interest Only (IO) repayments.
Taking out a P&I loan means you make repayments on both the interest and the principal loan amount. These types of loans generally have a lower interest rate than IO loans.
With an IO loan, you only pay the loan’s interest without paying back any of the principal. This lowers your monthly repayment instalments and may free up some extra cash in the short term. The interest rate could be higher than a P&I loan and there is generally a fixed period where you can utilise IO repayments. Once the IO period ends, your repayments will jump higher as you now have to repay the principal as well as the interest.
Interest Rate types: Variable rate vs fixed rate vs split loans
These three types of loans are differentiated by whether your interest rate will regularly change with the market, or if it stays the same for some years at a time.
Variable rate loans
This type of loan gives you the most flexibility in managing your home loan, however it also means your interest rate may go up or down over the life of your loan based on factors such as the official cash rate and market funding costs.
Depending on your lender, your variable rate home loan may come with features like the ability to make unlimited additional repayments and access to redraw additional funds when you need them. Remember to check any features, benefits or restrictions of your home loan before locking in your interest rate.
Pros: If the cash rate decreases or your lender reduces rates, your interest rate may decrease, meaning you pay less interest. Often you are also able to make extra repayments, which could help you pay off your home loan faster.
Cons: If the cash rate increases or market conditions worsen, your rate could increase, which means you’ll pay more interest.
Fixed rate loans
With this type of home loan, the interest rate on your loan will stay the same for a set period, usually between one and five years. This could help you set a budget for repayments and protects you from increases in market interest rates.
If you lock in a fixed interest rate, it’s important to note that fees may apply if you want to make a variation to your loan or exit the fixed rate loan early, including if you decide to refinance your loan or sell your property. These fees are known as break costs and can be significant.
Pros: Protection against rising interest rates. Set repayments that are easy to budget for.
Cons: Fixed loans tend to be less flexible, and limits may apply to additional repayments. If market rates fall, you could pay more on your home loan and if you want to end your fixed rate period early, you might be required to pay a fee.
Split rate loans
Some lenders may let you split your home loan into two parts: one part of your home loan can have a fixed rate, while the remaining portion has a variable rate. This means you could get some protection from rising rates but still maintain some benefit from any interest rate cuts.
Pros: Provides some protection against rising rates for the fixed portion while the variable rate portion of the loan may capture the savings of any rate cuts. You might also be able to make additional repayments on the variable portion.
Cons: You may not be able to apply extra repayments to the fixed portion of your loan.
Other types of home loans
Within the categories of variable, fixed and split rate home loans, there are a still even more types of home loans available. Each of these home loans address different needs, so you could find the one type that suits you.
Basic home loans
‘Basic’ home loans are no-frills home loans that sometimes come with a lower interest rate and fees, but fewer features than other home loan types. The definition of ‘basic’ varies between lenders so check carefully which features are available with any home loan.
What’s important for you is to choose a home loan that only has features you are likely to use now or in the near future, so you don’t pay a higher interest rate than necessary.
Offset home loans
An offset home loan involves linking a savings or transaction account to your home loan.
Instead of receiving interest on your linked account — like you would get in a regular savings account or term deposit — the balance of the offset is deducted from your home loan when monthly interest is calculated. For example, if you have $20,000 sitting in your linked account and the value of the home loan is $350,000, you will only pay interest on a home loan value of $330,000.
The more you have saved in your offset account, the more you could save on home loan interest.
Package home loans
A package home loan which is sometimes called an ‘ongoing discount’ home loan, combines a home loan with other financial products like a transaction account or credit card.
One the upside, you could receive 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. It’s important to weigh up whether the fee savings and rate discount are worth more than the annual package fee.
Line of credit
This type of home loan allows you to draw from a fixed amount at any time, to pay for whatever you want — shares, renovations, or even a holiday.
It’s like having a credit card with a large limit, but your home still acts as security for the home loan. The amount you can borrow using the line of credit depends on the equity of your home which calculated from the value of your home less your remaining mortgage debt.
These are home loans designed for self-employed people who don’t have the normal financial documents most people use to prove their income. If this sounds like you, your local Aussie Broker can help you sort out other paperwork.
A low-doc loan can be either fixed or variable, though the interest rate is generally higher than regular doc loans.
Additional mortgage features
Home loan features matter because they can help you enjoy savings, convenience and flexibility on your loan. Some additional loan features to consider include;
- Extra repayments: paying a little more off your loan when you have some spare cash available cuts time and interest from your loan.
- Redraw: this allows you to access any extra repayments made into your home loan as cash.
- It can be useful if you need cash for unexpected bills or anytime you need extra funds.
- Choice of repayment frequency: it may help to time your loan repayments with pay days.
Introductory rates and honeymoon periods
Some lenders offer a low introductory rate to help you ease your way into a home loan. A home loan’s ‘honeymoon period’ is a temporary amount of time — often between a few months and two years — when the rate on your loan is lower than normal. This gives you the chance to get into the swing of living with a home loan, plus it can leave you with some extra cash every month to spend on things like kitting out your home with furniture.
Just like real honeymoons don’t last forever, your loan’s honeymoon period will come to an end too. When that happens, you need to be ready for the loan rate to rise to what is called the ‘revert rate’. This is the ongoing rate you’ll pay on your loan and could be much higher than what you had been paying.