Finding the right home loan can be a lot like finding a romantic partner. There’s many to choose from, but few to match your needs. Some will reject you, some you’ll dump after a while and some you’ll be stuck with for over 20 years.
- How many types of mortgages are there?
- Different types of home loans
- Types of interest rates
- What’s a split home loan?
- Principal & interest or interest-only?
How many types of mortgages are there?
There are quite literally thousands of home loan products on the market for a range of different purposes. Having this many options can be overwhelming, leading many to rush into making a bad choice. And like a bad relationship, the wrong home loan can have a significant impact on your finances and your standard of living.
Different home loans will be more beneficial (and often required) for certain circumstances, so it’s worth knowing which type of home loan can be used for what purpose. So we’ve briefly summarised each of the main types of home loans below and how they work.
The different types of home loans
The following types of mortgages are commonly used around Australia:
- Owner-occupier home loans
- Refinance home loans
- Guarantor home loans
- Investment home loans
- Low-doc home loans
- Reverse mortgages
- Construction loans
- Bridging loans
- Line of credit home loans
Low variable mortgage rates
Base criteria of: a $400,000 loan amount, variable, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 75%. The product and rate must be clearly published on the Product Provider’s web site. Introductory rate products were not considered for selection. Monthly repayments were calculated based on the selected products’ advertised rates, applied to a $400,000 loan with a 30-year loan term. Rates correct as at 17 February 2020. View disclaimer.
1. Owner-occupier home loans
Owner-occupier home loans (OO) are for borrowers that will be living in the property for which the home loan is being used to buy. These are your stock-standard home loans – there are hundreds of them on the market from more than a hundred different lenders and banks, and they can be used by a variety of people, whether you’re a first home buyer or a refinancer.
Owner-occupier home loans often have lower interest rates on average compared to other sorts of loans, like investment home loans, since they’re used for a property that will likely be your main residence for years to come, making you more likely to hang onto it.
2. Refinance home loans
While you’ve probably heard of refinancing before (and may well have done so already, given a large portion of home lending every month is for the purpose of refinancing), ‘refinancing home loans’ generally aren’t a product. Lenders might advertise home loans to attract customers looking to refinance, but many home loans will generally be available for people refinancing or purchasing a house.
So don’t get confused when you can’t find any ‘refinancing home loans’ – they’re just regular home loans you can refinance to, whether that’s with another lender or the one you’re with now. By refinancing your home loan to a new loan with a lower interest rate or better features, you could save yourself thousands of dollars over the course of your loan period.
3. Guarantor loans
A guarantor home loan isn’t actually a specific product either. There are home loans that allow the use of a guarantor, who is someone (usually a close family member like a parent) who agrees to take responsibility for making repayments in the event that you can’t. Guarantors can be useful for people with low incomes or those who are struggling to reach their deposit goal, since some lenders allow guarantor-backed customers to take out a 0% deposit home loan.
4. Investment home loans
An investment home loan is a home loan for people looking to buy a property for investment purposes, which typically involves renting it out and profiting through a rise in the property’s value. They tend to have higher interest rates and stricter eligibility criteria than owner-occupier loans since investors are usually considered riskier borrowers than those buying a property to live in.
There can be tax benefits to taking out an investment home loan, as the Australian Taxation Office (ATO) states interest payments (among other things) can be claimed as a tax deduction.
5. Low-doc home loans
A low doc home loan is a low documentation home loan, available to those that don’t have the correct proof of income documents available, such as:
- Income details: copies of most recent payslips, pay summaries, rental income statements and dividends etc.
Low-doc home loans often have higher interest rates and fees to compensate for their more generous lending restrictions, and they aren’t offered by as many mainstream lenders as owner-occupier or investment loans are.
6. Reverse mortgages
Reverse mortgages allow people who are asset-rich but cash-poor (and usually over 60) to access the equity in their home. Reverse mortgage borrowers do not have to make repayments while living on the property, but like any loan, interest is charged on the balance, and when they sell the home or pass away the loan needs to be repaid in full, including interest.
According to ASIC, reverse mortgages can create financial difficulty later in life for a number of reasons:
- Interest rates and fees are generally higher than standard home loans
- Compound interest can cause your debts to increase as your interest-owed does
- If the value of your home doesn’t rise you will have less money for future needs (like medical treatment)
- Reverse mortgages can affect your pension eligibility
- Fixed reverse mortgages can be costly to break
The older you are, the more you can borrow with a reverse mortgage. Generally, 60-year-olds can borrow roughly 15-20% of the value of the home, while 70+-year-olds can usually borrow 25-30%.
7. Construction loans
A construction home loan is a mortgage you take out when you are either building a new home or you are doing a major renovation. Unlike a regular home loan, construction loans cover expenses as they occur during the construction process, something that’s called progressive draw-down. These payments usually occur in a five to six-stage process, which are often the following:
|Deposit||Paying the builder to begin construction|
|Base||Concrete slab complete or footings|
|Frame||House frame complete and approve|
|Lockup||Windows/doors, roofing, brickwork, insulation|
|Fixing||Plaster, kitchen cupboards, appliances, bathroom, toilet, laundry fittings/tiling etc.|
|Completion||Fencing, site clean-up, final payment to builder|
If one of these stages (such as the base) costs $100,000, then you only pay the loan’s interest rate on that $100,000. The rest comes later. Most lenders charge slightly higher interest rates for construction loans.
Low rate construction loans
Base criteria of: a $400,000 loan amount, variable construction home loans with an LVR (loan-to-value) ratio of at least 80%. Introductory rate products were not considered for selection. Monthly repayments were calculated based on the selected products’ advertised rates, applied to a $400,000 loan with a 30-year loan term. Rates correct as at 17 February 2020. View disclaimer.
8. Bridging loans
A bridging loan is a loan designed to help you when you’re in the transition period between selling your old home and buying a new one. It’s technically an additional home loan you take out on top of your current one, with extra money given to you to help buy your second property while the other sells. During the ‘bridging period’ you have two loans – typically interest-only repayments – and when the current home is sold the bridging component is added into your chosen loan for your new property.
Bridging home loans are usually shorter, often up to a maximum of 12 months in most cases, and often come with a higher interest rate than standard home loans. Some lenders don’t charge higher rates though, so look around.
9. Line of credit loans
A line of credit home loan is a loan that is borrowed against the equity of your home. Line of credit loans can actually be a home loan feature – it’s essentially a sort of ‘credit limit’ where you can swap the equity you’ve built up in your home for cash, up to a certain amount (the credit limit) set by the lender. A line of credit loan is typically reusable, meaning you can borrow and repay funds up to the credit limit as much as you like, which makes it similar to a credit card, except with much lower rates.
Line of credit loans can be used for things like:
- Home renovations and repairs
- Buying a second house
- Buying a car
- Taking a holiday
- Paying for a wedding etc.
Line of credit loans tend to be interest-only, but the home loans that offer them often have higher interest rates and administrative fees.
Types of interest rates on a mortgage
Before we get into the different types of home loans, we’ll quickly recap the different types of interest rates, because this too can make a difference to how much you pay.
Fixed interest rate
A fixed interest rate is a ‘locked’ rate: it doesn’t change for a set period of time, usually between one and five years. Customers can take advantage of this by locking in a lower interest rate if they expect rates to rise in the coming months/years. On the other hand, fixed-rate loans can disadvantage borrowers if rates continually drop – you normally have to cop a break fee if you choose to break the fixed component of your loan contract before the term is up.
Variable interest rate
A variable interest rate is a loan with an interest rate that changes based on market forces. This means your interest rate could regularly change over the life of your home loan, which could quite significantly impact your monthly repayments. Variable home loans are generally more flexible and can also have appealing features like the ability to make extra repayments (often at no extra cost) to help you pay off your loan sooner, but don’t have the budgeting certainty a fixed-rate loan provides.
Read our article on fixed vs variable home loans to gain a greater understanding of the pros and cons of each.
What is a split home loan?
A split home loan allows you to get the best of both worlds – fixed and variable. A split loan splits your repayments into a fixed-rate component and a variable-rate component.
At the end of the fixed-rate period (up to five years), that fixed portion of the split loan will often revert to a ‘rollover rate’ usually specified in the terms and conditions. This rate can be higher than the variable component of your home loan, and essentially means you’ll be on two different home loan interest rates for the remainder of the loan term.
Principal & interest or interest-only?
Principal & interest repayments
The term ‘principal and interest’ (P&I) refers to two components of your home loan repayments:
- The principal, which is the initial amount you’ve borrowed for the loan
- The interest, which is the cost charged by the bank to borrow the money
So if you borrowed $400,000 for a home loan at a 4.00% p.a. interest rate, that $400,000 is the principal which you have to pay back, while the interest is what you pay back on top of that principal (4.00% per annum on the balance owing). With each principal & interest repayment, an increasing portion of the payment will go towards paying off the principal and a decreasing portion will go towards paying interest, since you’re chipping away at the balance owing right from the beginning.
Interest-only (IO) loans, on the other hand, delay the repayment of the principal (aka the borrowed amount), for up to five years, although in some cases you can pay interest-only for up to 10 or even 15 years. During this time you only need to repay the interest component, before reverting to principal and interest afterwards.
For this reason, IO loans can be much cheaper to start with since the repayments will be much smaller. But once that IO period is over, repayments can jump significantly, and they can be more expensive overall.
The table below shows the difference in monthly and total repayments of an IO and P&I home loan, based on a 30-year loan of $400,000 at an interest rate of 4.00% p.a.
|Loan||Monthly repayment during IO period||Monthly repayment after IO period||Total cost (principal + interest) of the loan|
|Total cost difference||$25,926|
In this instance, the interest-only option is more than $25,000 more costly – and that’s without even taking into account the fact that IO loans typically have higher interest rates than P&I loans, not to mention the high revert rates at the end of the IO period.
Savings.com.au’s two cents
There are a bunch of different home loan types out there, and when you mix them up you get thousands of different variations of home loans on the market. For example, you can get a variable P&I owner-occupier loan, a fixed IO investment loan, a split home loan, a low-doc home loan with added features like an offset account, a home loan that allows a 5% deposit as well as the use of a guarantor…we could go on like this.
The takeaway is there is no one “best” product on the market, but there are certainly ones out there that are better for you based on what you’re after. And some loans will be unsuitable. For example, you can’t take out a construction loan for an existing property, and it would also be inefficient to apply for a low-doc home loan when you can easily provide proof of income in your application.
In most cases, what is really important is the interest and the principal you end up paying. So with this in mind:
- Look to buy a home in a price range you won’t struggle to afford
- Try to find a loan with a low interest rate, as this will make a real difference
You don’t necessarily need the lowest interest rate on the market, as there might be a more suitable product for you with a slightly higher rate. But for purchases as gargantuan as a home, even the small difference in the interest rate can lead to tens of thousands of dollars difference.
The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:
- The big four banks are: ANZ, CBA, NAB and Westpac
- The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2019. They are (in descending order): Credit Union Australia, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
- The larger non-bank lenders are those who (in 2019) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site.
In the interests of full disclosure, Savings.com.au and loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.
*The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate.
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