Types of home loans in Australia

In broad terms, there are three types of home loans in Australia — fixed, variable and split-rate loans. With a fixed rate loan, your repayments will remain consistent throughout the term of the loan due to the fact that the interest rate is fixed in place, while with a variable rate one, your interest rate can shift up or down, depending on market conditions and your lender’s decision. Split rate loans combine elements of both.

That said, within these overarching categories, there are a number of different home loan options and mortgage types for you to consider, with different features and requirements. Here, we explain some of the different types of home loans in Australia to untangle the complexity and potentially help you decide which option may be right for you.

Variable home loans

A variable rate home loan is one in which the interest rate is changeable and can fluctuate depending on market conditions, including movements of the RBA cash rate, and decisions of the lender. This means interest repayments on a variable rate home loan could go up or down at any time, and if lenders raise rates after you sign up, your monthly repayments could get more expensive. The reverse can also be true though, and if lenders cut rates, you can enjoy the benefits of lower repayments.

Variable rate loans also tend to come with an array of features, like offset accounts, redraw facilities or the ability to make extra repayments. Offset accounts can be appealing as they can function as everyday bank accounts while lowering the principal of your loan and thereby lowering the amount of interest you’ll be charged. These features do, however, tend to make variable rate loans more expensive than fixed rate ones, due to the fees you’ll be charged.

There are a few different types of variable-rate home loans which may be offered by lenders. Most often they include:

• Basic Variable Rate: Tends to focus more on competitive rates than features and repayment flexibility. Basic variable rate home loans also tend to have lower account fees (such as establishment fee or ongoing service fees)
• Standard Variable Rate Mortgage: Standard variable rate home loans tend to have more flexibility in repayments and available features attached to the loan. This may come with a slightly higher interest rate than the basic form of mortgage.

Fixed rate home loans

A fixed-rate home loan is one in which the interest rate you pay is locked in place or ‘fixed’ for a set period of time. This period of time can vary but is typically between one and five years.

When you take out a fixed-rate home loan, you are guaranteed that the interest rate you pay between each repayment period will not fluctuate and that your repayments will (generally speaking) remain the same. This can be desirable for those who want a sense of security with their mortgage repayments in an environment where interest rates are fluctuating, but if lenders lower rates, you will not enjoy the benefit.

That said, in general, fixed rate home loans tend to come with fewer features such as offset accounts or redraw facilities. Additionally, unlike a variable-rate home loan, you’ll generally find fixed-rate mortgages often don’t allow for additional repayments, or have limits on the extra amount you can repay within a set timeframe (such as in a year).

At the end of a fixed term, you can typically choose to either move into a variable rate home loan, or refinance to either a split-rate home loan or another fixed-rate home loan.

It is also generally possible to break out of a fixed-rate home loan before the ‘fixed’ period ends, although it is likely your bank or lender will charge you a break fee to do so.

Split home loans

Split-rate home loans, in a sense, offer the best of both worlds: a mortgage that splits the loan amount into different rate types. For example, you might decide to split your mortgage in two equal portions, with one half in a fixed-rate loan and the other in a variable-rate loan. This type of home loan could provide a bit of stability with its fixed rate — as repayments on that portion remain consistent throughout the fixed period — as well as flexibility — such as extra features or repayments — through the variable-rate portion.

That said, the ability to split your home loan is not always offered and could depend on the rules of the lender, so it is always worth checking whether a particular loan you are considering can be used as part of a split arrangement.

Additionally, although the variable rates aspect of a split home loan can still come with features, there may be restrictions or limits to those features compared to a variable-rate-only home loan. And, it’s important to remember that if interest rates change, so too will your repayments change on the variable portion of the loan.

Principal-and-interest home loans

A principal-and-interest (P&I) mortgage is a type of loan where the borrower repays the loan amount as well as the interest charged by the lender from the very start of the term. In other words, from the beginning, your regular repayments will go towards paying down the loan amount (the principal) as well as the interest that’s added on top.

Principal and interest loans are generally the most commonly-offered home loan repayment set up, and will allow you to begin repaying your home loan from the moment you take possession, thereby lowering the principal and reducing your interest payments over time. The main alternative to this type of loan repayment is an interest-only loan.

Interest-only home loans

An interest-only home loan is a type of repayment set up for your home loan where you only repay the interest on the amount borrowed for a set period of time. Unlike a principal-and-interest loan, you won’t need to pay the loan amount (the principal) during this set period. Once the interest-only loan period has passed, the home loan typically reverts to a principal-and-interest loan.

Because borrowers aren’t required to pay the principal at the beginning of the loan, interest-only loans tend to have smaller repayments in the beginning when compared with a principal-and-interest loan of the same size. This can make them appealing for home buyers who want to get a foot on the property ladder but also want to delay larger repayments for a few years.

However, it’s worth remembering that you’re unlikely to save by structing your loan this way. Moneysmart warns that interest rates for interest-only loans are often higher than principal-and-interest loans. This means that you’re more likely to end up paying more over the lifespan of your mortgage with this type of loan.

RBA statistics reveal that interest-only home loans are more popular among investors than owner-occupiers. Typically, an interest-only loan period can be a maximum of five years for owner-occupiers, but it may be longer for investment home loans.

First home buyer loans

The majority of Australian lenders offer a specific type of first home buyer mortgage. These home loans tend to have additional features and conditions such as potential cashbacks and lenders mortgage insurance (LMI) discounts.

There are also government schemes available to first home buyers that may help boost your borrowing potential. These include, for example, the Australian Government 5% Deposit Scheme, where the LMI can be waived on home loans with a loan-to-value ratio (LVR) as high as 95%. There are also first home owner grants and concessions available in each state and territory.

But, even with these incentives and government aid, first home buyers statistically have higher financial risks than other borrowers. RBA noted in a 2022 report that job security and income growth was a likely factor in helping first home buyers from experiencing financial stress with their mortgage repayments.

Investment home loans

An investment home loan is taken out specifically to fund the purchase of an investment property, as opposed to an owner-occupied loan where the property purchased is typically for the borrower to live in.

Lenders tend to view investment home loans to be riskier than an owner-occupied loan as the rental market can be uncertain and volatile. The perceived risk may include the potential for the property to become vacant for a period and not generate income, which can then pose a risk to the owner’s ability to make their mortgage repayments. Additionally, there tends to be more ongoing maintenance costs involved in an investment property that the owner needs to account for in their finances.

With these factors in mind, investment home loans can potentially have stricter conditions and higher interest rates than owner-occupied mortgages.

Guarantor home loans

If you want to enter the property market but don’t have a large enough deposit for a home loan, a guarantor loan might be something to consider if you have someone close, such as a family member, willing to help.

A guarantor home loan names a ‘guarantor’ who offers the equity in their own property as additional security against your loan. This typically means your loan will be approved with a smaller deposit than the expected amount for the loan. You may also be able to save on the cost of lenders mortgage insurance (LMI) with a guarantor home loan.

Of course, you must also consider whether you’re able to afford the mortgage repayments before looking to apply for a guarantor home loan. It’s important to note that if you are unable to pay the loan back, the guarantor could be held liable for the loan and have to make any missed repayments on your behalf, which can strain family relationships. Therefore, it’s important to think carefully about your financial position and your ability to repay a loan before approaching a trusted person to be a guarantor.

Low-doc home loans

Low-doc home loans are suitable for those who do not necessarily meet standard lending criteria, when it comes to providing the required paperwork, but have a good credit history (unlike a non-conforming loan). This type of home loan is typically aimed at self-employed people, contract workers, small business owners or even investors who rely on their investment income. It’s common for lenders to ask borrowers to provide an Australian Business Number (ABN) when applying for a low-doc loan.

However, low-doc loans tend to come with higher interest rates, larger deposit requirements and potential terms that restrict borrowers.

Non-conforming home loans

A non-conforming loan is a potential home loan option for borrowers that don’t meet the typical lending criteria set out by banks and other major lenders. These could be borrowers who have a poor credit record, past record of bankruptcy, or difficulties proving income.

Non-conforming loans work very similar to a typical home loan, the difference is usually the costs involved (such as higher interest rates and upfront fees). The ongoing and exit fees may also be higher than a typical home loan. These additional costs compensate lenders for the extra risks they take on when providing non-conforming home loans.

Home equity loans

Home equity is the difference between the value of your home and how much you still have to pay on your mortgage. An equity loan allows you to borrow money against your home equity. This type of loan is often used for renovations, property investment and, in some circumstances, debt consolidation. There are a number of ways that you may be able to use your equity to borrow money, such as:

• apply for a line of credit loan
• if your current mortgage allows, access funds from your additional repayments using a redraw facility
• refinance your mortgage while taking advantage of your current home equity.

Line-of-credit home loans

A line-of-credit home loan is a type of equity loan that allows customers to borrow money using the equity in their property. It’s called a ‘line of credit’ because the lender approves a loan up to a set amount, but the borrower does not have to take the full amount straight away. They can take out funds when the need arises, up to the set credit limit. This type of loan allows borrowers to flexibility withdraw from the loan for investments, renovation or emergencies without the hassle of going through the application process each time.

However, line of credit loans tend to have higher interest rates than standard home loans, and the terms and conditions tend to be stricter, too.

Bridging loans

If you already own a home, with its own ongoing mortgage repayments, a bridging loan could be something you consider when purchasing a new property while you’re still in the process of selling your existing property. A bridging loan is a special type of short-term loan that can cover the purchase price of another home during such a scenario. It’s a financial “bridge” for homeowners trying to traverse the gap between buying and selling.

However, this type of home loan comes with its own risks and costs that may not be suitable for everyone. Bridging loans typically are interest-only home loans that have short loan terms, usually 12 months, and the loan amount will be calculated against the equity of your current property. They also have special conditions attached that generally involve interest rates and whether the current property can be sold within a certain timeframe. It’s important to read all important documents when considering taking on such a loan, such as the Target Market Determination (TMD), Key Facts Sheet (KFS).

Construction home loans

A construction loan, sometimes known as a construction option or building loan, is a type of home loan taken out for the purposes of either building a new home from the ground up or making major renovations. It allows home buyers to allocate their funds towards each stage of a construction process.

Construction loans also commonly have a ‘progressive drawdown’, which means you may receive chunks or instalments of the loan amount at various stages of the construction process, instead of receiving it all at once at the start. You also generally only pay interest on the amount that is drawn down, as opposed to the whole loan amount.

A construction loan can be more complex than a regular home loan as additional documents are usually required during the application process. These can include council-approved plans, building specifications, a copy of your fixed-price building contract with a licensed builder, and any applicable insurance documentation (such as a copy of your builder’s public liability insurance).

Home renovation loans

Renovation loans often come in the form of a home equity loan, either through a line-of-credit loan or by refinancing your current home loan.

For larger projects that require a larger fund, typically involving external renovations or additions to the house, you may require a construction loan instead.

Home loans for seniors

Seniors looking for a mortgage may be wondering if they would be approved for a typical type of home loan, which has a range of application requirements such as a regular fixed income and the ability to pay back the loan over two or three decades. However, there are options outside of the regular home loan to consider, such as a reverse mortgage. This is where seniors or pensioners who already own property apply for a loan using their equity as security. The lender then pays that sum to the borrower, as a lump sum, an income stream or as a line of credit. Older Australians may also consider the Home Equity Access Scheme, which allows eligible Age Pension recipients to access the equity in their home. However, in this scheme, the government provides the loan. Also, other products, such as investment loans, may also be available.