Home loans explained
The different types of home loans
12 min read
Each type of loan has pros and cons, and there isn’t one that’s right for everyone. The important thing is to do your research and make sure you get the one that’s right for you.
When you’re starting to look at home loans it can feel a little overwhelming. Variable or fixed, principal and interest or interest only payments, and whether the loan is for a live in or investment property, are all things that determine the sort of home loan you have.
A variable rate can change at any time and is often influenced by the market and cash rate set by the Reserve Bank of Australia (RBA). It can either increase or decrease at the lender’s discretion. You can find out more about what influences variable rates to change by reading our article why variable rates change.
A variable interest rate gives you more flexibility and generally allows you to make extra repayments on your loan. It’s also good if your situation changes and you need to change your home loan (e.g. refinancing to renovate).
Although they offer lots of flexibility, a variable rate is subject to change. While you may start with an awesome low rate, that rate may rise over the lifetime of the loan.
A fixed rate on the other hand is locked in for a period of time (normally 1-5 years depending on what you choose). During this period your interest rate can’t go up, but it also can’t go down. Changes in the market and the RBA cash rate don’t impact your fixed rate. After your fixed period ends your interest rate changes to the variable roll-to rate that is in your home loan contract.
A fixed rate is a good way to lock in a low interest rate for a set amount of time. It also gives you certainty of your repayment amount so you can budget accordingly. If you’re lucky enough to have a lender that offers offset accounts with their fixed rate loans, you can leverage your offset account to help pay off your loan sooner.
A fixed rate doesn’t come with a lot of flexibility for your home loan. Generally extra repayments are limited or capped, and if you decide to change loans during your fixed period, you’ll be looking at paying a break cost fee on top of the other costs associated with refinancing.
A split rate home loan is a mixture of both variable and fixed interest rates. Essentially a portion of your home loan is on a variable rate and a portion is on a fixed rate.
A split rate lets you have the best of both worlds. So if you’re unsure about fixing your entire loan to a rate, you can just fix a portion and keep some of your loan on a variable rate. This way if interest rates rise, you won’t be as bad off, and if interest rates lower, you still get to benefit.
Not every lender will offer a split rate option. Tic:Toc for instance currently doesn’t offer this with our home loans.
An introductory (or honeymoon) rate is a reduced rate designed to attract new borrowers. The offer runs for a set period of time, after which the interest rate increases again. Tic:Toc doesn’t do honeymoon rates, instead we offer low rates all the time and our rate changes are based on our funder (Bendigo and Adelaide Bank) and the RBA cash rate.
Honeymoon rates are appealing because they offer you lower repayments upfront and save on interest during the honeymoon period. You can also use the honeymoon period to pay off more of your loan by making larger repayments.
Once your honeymoon period ends you could end up with an interest rate that is not as competitive as those currently on the market. Meaning you’ll need to refinance in order to get a better rate.
A live-in home loan (also known as an owner occupied home loan) is for a property that you plan to live in once you have purchased it.
Live-in home loans typically have a lower interest rate than investment home loans, so your repayments will be smaller.
If you take out a live-in home loan on a property, you’ll be required to live in the property for a certain period (typically one year). So if you’re planning to rent out the property, you’ll need to wait until that period of time is over.
Investment home loans are for properties you are buying as an investment.
Investment home loans allow you to rent out the property as soon as you’ve bought it.
In 2014 the Australian Prudential Regulation Authority (APRA), announced that banks had to reduce the proportion of investor home loans they approved to 10% of their total home loans. In response to this, lenders lifted their investment home loan rates to try and slow down the amount of investment home loan applications. As a result, you will typically need to pay a higher interest rate if you are looking at getting an investment home loan
There are two parts that make up your home loan, the principal and the interest. The principal is the initial amount of money that you borrowed, and the interest is the amount your lender charges for borrowing the money.
By choosing principal and interest loan repayments you are agreeing to make payments that cover the interest the lender charges each month, as well as paying an amount towards the principal amount of your loan.
Principal and interest payments help to pay back your loan quicker and increase the equity in your home. It also means that you will be paying less interest over the lifetime of the loan because you’re paying back the principal amount you owe.
Making principal and interest payments will mean that your monthly repayments are larger than if you were to make interest only repayments. And there are also fewer tax benefits for this type of repayment.
Interest only repayments mean you are only paying off the interest that is accrued on your home loan each month. You can only make interest only payments for a set period of time (typically 1 to 5 years depending on the lender) before you switch to principal and interest repayments.
Interest only repayments keep your monthly repayments lower than if you were paying principal and interest. There are also more tax deductions for interest only repayments which can be beneficial if you are an investor.
Just like fixed rates, interest only periods aren’t forever, eventually you’ll need to start paying off your principal as well. Only paying the interest on your home loan also means that you’ll end up paying more interest over the lifetime of the loan because you aren’t lowering your loan amount during your interest only period. It will also mean that the equity you have in your property is reliant on the property market. If your property doesn’t increase in value during your interest only period, you may not have any equity in your home until you start paying off the principal.
When it comes to home loans, there's a real mixed bag of options.
A standard deposit is 20% of the amount you are planning to borrow (e.g. $100,000 if you plan on borrowing $500,000).
With a standard deposit you won’t need to pay Lenders’ Mortgage Insurance (LMI). You won’t be as restricted when picking a home loan, and you’ll be able to get a lower rate than that of a low deposit home loan.
To get a standard deposit you’ll need to save up for longer. So if you find your dream home before you’ve saved up enough for a standard deposit, you may have to look at a low deposit option.
A low deposit is anything less than 20% of the amount you want to borrow. Different lenders will accept different amounts of deposits, some even going as low as 5%. Currently Tic:Toc offers a 10% low deposit home loan.
You’ll be able to buy your property sooner because you won’t need to save up as much of a deposit.
You’ll need to pay LMI when getting a low deposit home loan, and the interest rates will normally be higher than standard deposit home loans.
If you’re self-employed and looking to get a home loan, often you’ll need to provide 2 years’ worth of up-to-date tax returns or business financial statements when applying for a standard home loan in order to validate your financial situation.
By providing this documentation you’ll be able to get a lower interest rate than if you went for a Low doc option.
If you’re newly self-employed you may not have enough paperwork to qualify for a standard home loan.
If you’re self-employed, a low doc home loan will allow you to apply for a home loan with less required documentation. Tic:Toc offers a self-employed home loan which allows you to apply with a customer declaration and accountant verification – and whilst Tic:Toc’s self-employed home loan isn’t exactly like other low doc loans, (because we use our technology to verify your income and expenses), we’ve simplified the process which gives us a more accurate overview of your financial situation without all the paperwork.
Low doc home loans give you the ability to apply as a newly self-employed person, or if you don’t have the standard paperwork for a typical home loan.
Low doc home loans are perceived as higher risk to the lender and will usually come with a higher interest rate than standard home loans because of this. So you’ll be paying more interest over the life of the loan.
A bridging loan is an additional home loan you can take out when you require finance to purchase a second property, while also trying to sell the first property. Once your first property is sold, the bridging loan is converted into your home loan for your new property. Tic:Toc don’t currently offer bridging loans.
Bridging loans allow you to purchase a second property while you are waiting for your current property to be sold.
These sorts of loans aren’t always available on every home, and not every lender offers them. They are generally interest only loans which mean you won’t be paying off any of the principal during your bridging period. And if you don’t sell your property in the agreed upon period, your lender may get involved, or the interest rate on the bridging loan may increase.
A guarantor home loan requires a guarantor (usually a close relative of yours) to agree to offer a portion of their home equity as a deposit for your loan.
Guarantor home loans can be a way to get into the market sooner. Because you have someone offering security for your loan, you can purchase with a smaller deposit.
Getting a guarantor for your home loan means you’ll need to ask someone to put their own home’s equity up as security. This can cause tensions if you aren’t able to make your loan repayments.
A construction loan is a home loan designed for borrowers who are building a home instead of buying an established one. They usually have progressive payments, which means your home loan starts off small, but gradually increases to the final amount as the construction progresses.
A land loan is a home loan designed for borrowers who are buying a vacant block of land. Normally the intention is that the borrower will build a home on this land.
Normally you are only expected to pay the interest on a construction loan during the construction period. So you can either enjoy the lower repayments while you have them, or take the opportunity to start paying off your principal amount sooner. You’ll also be paying minimal interest on your loan because your loan amount starts off small and gradually increases with each progress payment.
Getting a land loan means you can buy the land now and build your house later, giving you more time to save up.
Construction loans are considered to be riskier than home loans for pre-existing homes. This is because it is harder for a lender to value a property that hasn’t been built yet. This means that construction loans can come with higher interest rates than home loans for established properties. The progress payment method can also make construction slower because it can take time moving from one stage to another.
If you’re thinking of getting a land loan, you may need to save up more for a deposit. Many lenders offer a lower LVR (loan-to-value ratio) for vacant land home loans, meaning they will require a bigger deposit from you before you can be approved.
A line of credit loan gives you access to a set amount of credit whenever you need it. The loan is usually secured against the equity you have in your home and functions similarly to a credit card. You have a set limit of credit and you can borrow up to that amount at any time with interest charged on the outstanding balance.
Line of credit loans are normally easier to obtain than other forms of debt. They also offer you the convenience of being able to borrow funds any time you need them. And because you are securing the loan against your home equity, you will generally pay a lower interest rate than other forms of debt.
Because the loan funds are so easy to access, it can be easy for your line of credit loan to get out of hand if you aren’t disciplined with your finances. Using home equity to secure your loan means that if you have trouble making your repayments you could lose that equity. And because line of credit loans have no end date, the longer you take to pay back what you’ve borrowed, the more interest you will pay.
Debt consolidation loans are a way to combine all the loans and debt you owe into one loan. You can consolidate a variety of different types of debt by either taking out a personal loan, or refinancing your home loan, leaving you with one loan and one repayment.
Consolidating your debt into one loan turns several repayments into just one. It also gives you a chance to lower the interest rate are paying on your debt, saving you some money over time. A lower interest rate can also mean lower repayments which will make it easier on your wallet.
When consolidating your debt, you may be tempted to borrow more money than you need and end up accruing more debt. You may also end up taking longer to pay off your debt if you opt for lower repayments. And if you don’t get a low enough interest rate, you could end up paying more interest over the life of the loan, so make sure you do the math first.
No matter what sort of loan you are thinking of getting, it’s important to make sure it meets your needs and will be the right one for your situation. You can start looking at our different home loans here. Or if you need more info, you can always have a chat with us.