The most common types of home loans

When it comes to home loans, one size doesn't fit all. Understanding the nuances of different loan types is crucial in making the right choice.

For instance, owner-occupier home loans, tailored for those buying their primary residence, often come with favourable terms compared to investment loans, which are primarily designed for purchasing rental properties.

Each loan type, be it fixed, variable, or a more specialised loan like a green home loan or an SMSF loan, caters to specific financial needs and goals, making it essential to evaluate all options against your personal circumstances.

Main types of home loans in Australia

Owner-occupier home loans

An owner-occupier home loan is specifically designed for people purchasing a property they intend to live in as their primary residence. These loans often feature more favourable terms and interest rates compared to investment home loans due to the lower perceived risk for lenders.

Owner-occupier home loans come in various types, including fixed, variable, and split interest rates, allowing homeowners to choose a loan that best fits their financial situation and goals.

Investment loans

Investment loans are designed for purchasing properties intended as investments, rather than as a primary residence. These loans may have different terms and interest rates compared to owner-occupier loans due to the perceived higher risk. They often require a bigger deposit and may have stricter eligibility criteria.

There can be tax benefits to taking out an investment loan, as the Australian Taxation Office (ATO) states interest payments can be claimed as a tax deduction - which is why interest only loans are so popular among investors.

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Buying a home or looking to refinance? The table below features home loans with some of the lowest interest rates on the market for owner occupiers.

Important Information and Comparison Rate Warning

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Fixed rate loans

For those who value predictability or just want to lock in a low rate, fixed-rate home loans are a good option. They offer the security of knowing exactly what your repayments will be for a set period of time, often ranging from one to five years. This means no surprises on your monthly budget, even if interest rates fluctuate.

One of the most significant benefits of a fixed rate loan is the protection it offers against rising interest rates. If the cash rate increases and market rates follow, borrowers with a fixed rate loan continue to pay at their lower, locked in interest rate. However, this can also be a drawback if the official cash rate falls and the market follows, as borrowers are then locked into a higher rate.

Fixed home loans tend to be less flexible than variable rate loans, with limitations on extra repayments and potential penalties for breaking the fixed term early, known as break costs. Fixed home loans come in various types, including basic fixed rate loans, which offer fewer features but lower rates, and standard fixed rate loans, which may include additional features like offset accounts but at slightly higher rates.

Variable rate loans

On the other end of the spectrum are variable rate home loans, where interest rates ebb and flow with the market. This change is usually in response to movements in the broader economy, such as changes in the official cash rate set by the Reserve Bank of Australia (RBA). This option is akin to riding the economic waves – potentially beneficial when rates drop, but requiring a buffer for when they rise. It's perfect for those who are comfortable with a bit of unpredictability and are keen to potentially capitalise on lower rates.

The defining characteristic of variable rate loans is their flexibility. They often allow additional repayments at no extra cost, which can reduce the total interest paid over the life of the loan. This feature can be particularly appealing to those who anticipate improved financial circumstances or who wish to pay off their mortgage faster.

Variable rate loans often come with a range of features that can be tailored to suit individual needs. These can include offset accounts, which reduce the interest payable by offsetting the loan balance against the money held in these accounts, and redraw facilities, which allow borrowers to access extra payments they have made.

Green home loans

Green home loans, a relatively new addition to the mortgage market, are designed to encourage eco-friendly living, reduce energy consumption, and ultimately lower the carbon footprint of households.

Green home loans typically offer discounted interest rates or other financial incentives for purchasing or building homes that meet certain energy efficiency or sustainability criteria. The criteria might include solar panel installations, energy-efficient heating and cooling systems, or sustainable building materials.

Construction loans

As the name suggests, construction loans are specifically tailored for building or renovating homes. They differ from traditional home loans in that the funds are released in stages as the construction progresses, rather than as a single lump sum. This phased approach, known as progressive drawdown, ensures that you only pay interest on the amount of money you have used at each stage, which can be more cost-effective.

Construction loans are structured to align with the various stages of building, such as laying the foundation, erecting the framework, and completing the interior. The lender typically requires inspections at each stage before releasing further funds. Once construction is complete, the loan usually reverts to a standard home loan.

This type of loan is ideal for those planning to build a new home or undertake significant renovations, offering a structured approach to finance the construction process.

Bridging loans

Bridging loans offer a temporary financial solution for those looking to purchase a new property before selling their existing one. These loans fill the gap (hence the term 'bridging') in finances between buying a new house and selling the current one. They are typically short-term, usually up to 12 months, with higher interest rates compared to standard home loans. The borrower generally pays interest only during the term, with the principal due at the end, usually after selling the original property.

Bridging loans are particularly useful for those who find their dream home but haven't yet sold their current one. Bridging loans require careful financial planning due to their short-term nature and associated costs.

Low deposit loans

Low deposit home loans, also known as high loan-to-value ratio (LVR) loans, are designed for borrowers who haven't saved a typical 20% deposit. These loans can have a deposit as low as 5%, making home ownership more accessible for first-time buyers or those with limited savings.

However, these loans often require lenders mortgage insurance (LMI) to protect the lender against the higher risk associated with a smaller deposit. This insurance can add significant cost to the loan.

Low deposit loans can be a useful pathway into the property market, but borrowers should be aware of the higher interest rates and additional costs, like LMI, and ensure these are manageable within their budget.

Line of credit loans

A line of credit home loan allows homeowners to access the equity in their property, functioning similarly to a credit card with a limit based on the property's equity. This loan type provides flexibility, as borrowers can draw funds up to the established limit, repay them, and redraw as needed. It's beneficial for ongoing expenses, such as renovations or investments.

However, it requires disciplined financial management due to the potential for debt to accumulate quickly if not managed carefully. Interest rates on these loans may be higher than standard home loans and are calculated on the amount used.

Non-conforming loans

Non-conforming loans are designed for borrowers who don't fit the traditional lending criteria, often due to having a poor credit history, irregular income, or being self-employed. These loans can provide a pathway to home ownership for those who might otherwise be excluded from the mainstream mortgage market.

However, non-conforming loans typically come with higher interest rates and fees to offset the increased risk perceived by the lender. These loans are often a last resort for those unable to secure a standard loan and can offer an opportunity to rebuild credit history or secure financing in challenging circumstances.

Low doc loans

Low doc loans cater to borrowers who may not have the traditional proof of income required for standard home loans, such as self-employed individuals or small business owners. These loans rely on alternate documentation, like bank statements or accountant’s declarations, to assess a borrower’s ability to repay the loan.

While low doc loans can be a solution for people with irregular streams of income, they also often come with higher interest rates and fees due to the increased risk to the lender. Additionally, borrowers might need a bigger deposit or equity in existing property to qualify.

Interest only (IO) loans

Technically not a home loan itself, an interest only home loan is a mortgage repayment type where the borrower is only required to pay the interest on the loan amount for a set period, usually ranging from one to five years. During this period, the principal amount borrowed does not decrease as payments are not applied to it. This results in lower monthly repayments compared to a principal and interest (P&I) loan, making it an attractive option for certain borrowers, such as investors who may be focused on cash flow management.

After the interest only period, the loan typically reverts to a P&I loan, meaning repayments increase as the borrower begins to pay down the principal. This type of loan can be risky if property values do not rise, as it could result in the borrower having no equity built in the property when the interest-only period ends. Interest-only loans are generally suited for investors who anticipate a short-term hold of the property or those who expect a significant rise in income in the future.

Principal and interest (P&I) loans

A principal and interest (P&I) home loan is the standard mortgage repayment type where repayments cover both the principal amount borrowed and the interest charged. This structure ensures the loan balance decreases consistently over time.

Initially, a bigger portion of the repayment goes towards the interest, but as the principal reduces, the interest component decreases while the principal repayment increases. This loan type is ideal for those looking to build equity in their property steadily, as it results in full loan repayment over the agreed term.

P&I loans are widely chosen for long-term property investments and home ownership.

Split loans

Can't decide between fixed and variable? A split home loan gives you the best of both worlds. This type of loan allows borrowers to allocate a portion of their loan amount to a fixed interest rate and the remaining portion to a variable interest rate. Essentially, it's a way of hedging bets against interest rate movements, giving borrowers a mix of security and flexibility.

Borrowers can decide how they want to split their loan – some may choose a 50/50 split, while others may opt for a different ratio according to their financial situation and risk tolerance.

A split loan is ideal for borrowers who are uncertain about interest rate movements or who want to manage their risk. It's also suitable for those who desire the stability of fixed repayments but also want to retain some of the flexibility that a variable loan offers, such as making extra repayments without incurring fees.

Niche home loan types

SMSF loans

Self-managed super fund (SMSF) home loans are specialised mortgage products allowing SMSFs to borrow money for property investment. These loans are governed by strict legal and financial regulations. They offer a way for SMSFs to leverage their funds to acquire property, which can potentially provide rental income and capital growth.

These loans often have higher interest rates and require a more substantial deposit compared to traditional home loans. It's crucial for SMSF trustees to carefully consider the implications, ensuring compliance with superannuation laws and assessing the fund's ability to service the loan.

Reverse mortgages

A reverse mortgage is a type of loan available to older homeowners, allowing them to access the equity in their property without the need to sell it. Generally available to those over a certain age, often 60, reverse mortgages enable borrowers to receive funds as a lump sum, regular income stream, line of credit, or a combination of these. The loan amount, plus interest, is repayable when the borrower sells the property, moves out, or passes away.

Interest compounds over the period of the loan, which means the amount owed grows over time. As a result, equity in the home decreases as the loan balance increases. Reverse mortgages are regulated to ensure the borrower will not owe more than the value of their home, a feature known as a 'no negative equity guarantee'.

Reverse mortgages are often considered by retirees who want to supplement their income, fund home improvements, or cover healthcare expenses, while still living in their home. However, it's important for potential borrowers to consider the long-term financial implications, including the impact on their estate and any potential effect on pension eligibility.

Choosing the right home loan type

As you can tell, there are many different types of home loan products in Australia and choosing which one is right for you ultimately boils down to what kind of borrower you are, and what sort of property you’re looking to buy. For example, you can’t take out an investment home loan on a property you intend to permanently reside in, just as it wouldn’t make sense to take out a low-doc or non-conforming loan when you can easily provide proof of income in your application.

The key is to find a loan with a competitive interest rate and select the right type of loan that aligns with your specific situation. Whether it's a fixed, variable, or a more specialised loan type, the focus should be on how well it fits your financial circumstances, lifestyle, and property goals. It’s not always about the lowest rate but finding the right balance between rate competitiveness and suitability to your unique needs.

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