Types of home loans - the pros & cons
When you begin your search for a mortgage, you’ll soon discover there are a great range of home loans available. So to help you narrow down the right one for your financial situation, here are the main types of home loans in Australia:
Variable interest rate
The first consideration when it comes to comparing home loans is thinking about what type of interest rate you would like to go for. The more popular option is variable rates which are determined by your lender and could change at any time. Often lenders will shift their variable rates due to the Reserve Bank of Australia changing the official cash rate. So when rates are low you’ll benefit but you’re also vulnerable to rate increases.
The reason variable rate loans are a popular type of home loan is because they generally provide more flexibility, allowing you to switch providers if you like without incurring a break cost fee (often charged with fixed rate loans) and take advantage of features like a 100% offset account facility that will help reduce the amount of interest you pay.
It’s important if you’re going to go for a variable rate home loan, to see that you can reasonably afford a rate increase by punching in your details into a rate change calculator.
Example: Lauren’s current monthly repayments are $2,779 on a $500,000 home loan over a 25 year period. But if her variable rate of 4.5% increased by 75 basis points, her repayments would lift to $2,996.
Fixed interest rate
The alternative to a variable rate loan is locking in your interest rate for an introductory period of between 1 to 7 years. The biggest drawcard of choosing a fixed rate loan is your repayments will remain consistent during the fixed term, which makes this type of home loan popular for first home buyers or those on a strict budget.
However fixed rates are generally higher than variable rates and you’ll find it harder to switch home loans, as some providers charge an exit fee if you try to refinance during the fixed rate period. You’ll also lose out on some flexible features including a 100% offset account, but the good thing is these days many fixed rate loans come with an extra repayments facility.
Another thing you will need to keep in mind is that the longer the fixed rate term the higher the interest rate. For instance, just take a glance at the Greater Building Society’s fixed rates with its Ultimate Home Loan (Fixed, Package):
*Rates taken 5 August 2015
Split interest rate
If you’re finding it hard to choose between variable and fixed interest rates, then another option available to you is splitting your home loan, locking in a portion while the remainder is left variable.
This will mean that the portion that is fixed will not be subject to any changes in the market, while the variable portion will allow you to take advantage of features like an offset account. For example, if Lauren decides to split her $500,000 home loan with a 60:40 ratio, $300,000 would be fixed while $200,000 would be variable.
Other than interest rates the home loan you get will also depend on whether you are an investor or owner occupier. Some lenders in Australia are increasing their rates and reducing their maximum loan to value ratio requirements for investors, as the APRA puts pressure on banks to bring down their investment loan portfolios.
So if you’re an investor with a low deposit (e.g high LVR) you may not be eligible for the same loans as someone purchasing as an owner occupier and may also need to budget for higher monthly repayments due to a steeper interest rate. To see which loans are investor friendly, head on over to our our investment loans hub.
Interest only loans
A method of bringing down your monthly repayments is opting for an interest only loan, which will only require you to pay down the interest for a set period.
Example: Our home loan repayments calculator shows Lauren’s monthly repayments would drop from $2,779 to $1,875 if she chose the interest only home loan option.
This is a popular type of home loan for investors, as negative gearing means you may be able to get a refund on the interest when putting through your tax return. However, you should only choose an interest only loan if you are sure that the property will grow in value.
Also keep in mind, interest only periods don’t last forever (usually up to 7 years) and you will need to start paying down both the interest and principal after the interest only term comes to an end.
Low deposit loans
While lenders are tightening restrictions around investors with some requiring a deposit of at least 20% for investment loans, if you’re a purchasing your first home as an owner occupier (i.e you plan to live in the home) there are still a range of home loans out there that are available with just a 5% deposit.
Be mindful, low deposit loans come at a cost in the form of lenders mortgage insurance, charged by banks and financial providers when you have a deposit under 20%. Keep in mind, the insurance covers the lender’s loss (not yours) if you can’t repay the home loan.
If you’re on the hunt for your first ever property, we have two sections specifically designed for you. Our first home owners hub provides you with articles, tools and tips for navigating the property maze, while our first home loans comparison section allows you to compare the different home loans available for first home buyers in the market.
If you’re a first home buyer, to avoid the cost of lenders mortgage insurance and improve your chances of being approved for a home loan, you could consider asking your parents or a family member to go guarantor. This will mean a portion of their home will be used as security for the loan.
While this type of home loan has its advantages as you’ll get into the property market sooner, you and your guarantor should always weigh up the risks involved before going down this path.
Read more about guarantor loans with our tell all guide here.
Low doc home loans
If you own a business or work as a freelancer, you probably don’t have the same documentation as everyone else like a group certificate or letter from your employer.
A low doc home loan allows self employed people to apply for a home loan without the standard paperwork, at a cost in the form of a higher interest rate. You’ll still need to provide some documentation to the bank like a business activity statement and a borrower’s income declaration (to name a few).
Line of credit loans
Do you have equity in your home? Then you could consider refinancing to a line of credit loan through your current lender or a new provider. It’s just like a regular home loan that you repay over a set period of time, however comes with a revolving loan facility that you can draw on when you please.
While you’ll pay a higher interest rate for this type of home loan, you’ll get the flexibility of knowing you can draw on the agreed amount in one lump sum or in small portions as you go.
Line of credit loans are usually taken out by homeowners looking to renovate, which is often a smart move as renovating can add value to the property. However, it shouldn’t be used for impulse purchases, as drawing on a line of credit will only reduce the equity you hold in your home.
Full feature home loans
If you want a range of flexible features, then you can opt for a home loan with all the bells and whistles. Offset home loans are great for people who are going to take full advantage of the features on offer but keep in mind you’ll usually be charged a higher interest rates and fees. Here are some of the common features that come with these full packaged home loans:
Offset account: This is a great feature for bringing down the amount of interest you pay, as any money in the account will be offset against the principal of the loan. So if Lauren had a balance of $30,000 in an offset account she would only pay interest on $470,000, rather than the full $500,000 home loan amount.
Extra repayments: Another option that will bring down the interest charged is making additional repayments on top of your regular monthly repayments.
Redraw facility: When the time comes and you need a little cash, a redraw facility will let you access any extra repayments you’ve made on your home loan.
Home loan top up: If you need some money down the track for things like a home reno or new car, a home loan top up may come in handy. The amount that a lender will make available to you will be based on both the equity you hold in your home and your income.
Kicking off your home loan search
As you can see, when it comes to the types of home loans available there are plenty to choose between. So kick off your search by heading to our home loan hub, which compares everything from fixed and variable loans to first home loans and investment loans.
Alternatively if you want to compare our entire database, which includes over 100 home loans in the market today, use our home loan comparison tool.