Home loans come in different types and features, and some are often more beneficial for certain types of borrowers. If the seemingly endless array of mortgage products on offer has left you feeling a little dizzy, do not despair. Here is your one-stop guide for all mortgage types for your needs.
Variable home loan
Variable-rate home loans carry interest rates that change based on the movement of the cash rate or depending on lender discretion.
Key features of variable rate home loans
The two key features of variable rates are flexibility in rates and the ability to get useful loan features.
Interest rates of variable home loans track the interest rate movements set by the Reserve Bank of Australia (RBA). When the cash rate goes up, lenders usually pass on the hike to their borrowers. The same thing goes when the cash rate declines. In some circumstances, however, the cost of funding could compel many banks and non-bank lenders to raise rates independently of the RBA. This is called an out-of-cycle rate hike.
Despite higher rates, standard variable rates remain the most popular loan product in Australia, given the flexibility it provides to its borrowers.
There are two types of variable rate loans. These are standard variable and basic variable. Standard variable rate loans carry flexible features such as offset, redraw, extra repayments, and the ability to split the loan. Basic variable loans carry cheaper rates but often lack flexible facilities.
Advantages of variable rate home loans
A downturn in the cash rate means your repayments may be lower.
Variable rate loans are generally cheaper than fixed rates.
The flexibility in repayment without penalty is handy if you want to pay off your mortgage quicker.
You can reap substantial savings in interest.
Several loan features are available, many of which can help you pay your loan off sooner.
Take note, however, that if interest rates go up, the extra rate rise is charged on a monthly basis and added to the loan, making repayments higher. However, some variable rate loans can be capped.
Variable-rate home loans are suitable for: All types of borrowers who can allow for a marginal rate increase but wish to benefit if rates decrease. First home buyers should ensure they can still service their loan should rates increase.
Home loans with an introductory (honeymoon) rate
Home loans with an introductory rate are not necessarily a type of home loan per se, but a marketing strategy used by lenders to entice new borrowers. These loans are sometimes a good option for large home loans if introductory rate savings are greater than subsequent switch fees.
Key features of home loans with an introductory rate
The key feature of this loan is the honeymoon rates, which are usually some of the lowest interest rates available in the market. Interest rates are discounted for a certain period, which can vary for the initial months of the loan, depending on the institution and the product structure. After this 'honeymoon' period, the interest rate reverts to the standard variable rate, which is higher.
Advantages of home loans with an introductory rate
Home loans with honeymoon rates have the following benefits:
Borrowers pay lower installments during the honeymoon period.
The introductory period can help you get ahead financially as you prepare for bigger repayments.
Preparation is crucial when getting a home loan with an introductory rate. Once the honeymoon period ends, the interest rate reverts to a higher variable rate, which means higher repayments.
You must communicate with your lender to ensure you would not be paying a higher rate than the standard variable rate in the market, which could cancel out any savings.
There could also be an option to roll your rate into a fixed one. Check with your lender if they allow such an option.
Furthermore, ask your lender about the costs of discharging or switching the loan, and whether you can make extra repayments during the introductory period. You need to assess what the benefits are going to be over the long term rather than the short term.
Home loans with an introductory rate are suitable for: First home buyers who are breaking into the property market would benefit from the lower intro rates while they get used to paying off a mortgage. Home loans with an introductory rate are also worth considering if you are refinancing and need a short-term financial boost.
Fixed-rate home loan
Home loans with fixed rates carry the same interest rate for a certain period, usually up to five years. However, some lenders also offer fixed-term periods of seven to 10 years.
Key features of a fixed-rate home loan
Fixed-rate home loans are priced according to a pre-determined interest rate, which is independent of fluctuations in the official cash rate. You can fix your entire loan for a period of between one and five years, or you can fix a certain portion and leave the rest variable (this is called a split loan). When the fixed term expires, the fixed portion will generally revert to the lender's standard variable interest rate.
Advantages of fixed-rate home loans
Fixed-rate home loans help borrowers who are budget conscious. Here are some of the benefits of this type of home loan:
It protects borrowers from sudden changes in the cash rate.
There is a certainty in repayments given the fixed interest rate for a certain period.
Fixed-rate home loans can help borrowers manage their budgets given the fixed amount of repayments.
Take note, however, that one of the downsides of a fixed-rate loan is that lenders limit the amount that you can repay. There is also a big fee charged should you choose to break your fixed rate, known as break costs, on top of your standard exit fees.
Lenders apply this fee when rates start dropping below what you fixed your rate for, and it compensates them for what they would have earned had you not chosen to break the contract.
It is typical for fixed-rate home loans to allow for limited loan options in terms of features. They often charge fees for home loan features like redraw facilities. However, it is still best to ask your lenders about which features can be availed with your fixed-rate home loan.
To enjoy the benefits of both variable and fixed-rate home loans, you have the option to split your loan — a certain portion of your loan can be locked with a fixed rate while another portion will carry the flexibility of a variable rate.
Fixed-rate home loans are suitable for: Anyone who is concerned that interest rates may rise in the near term or who needs to know exactly what their repayments will be will benefit the most from fixed-rate home loans.
Construction loans are for borrowers who are planning to build or renovate.
Key features of construction loans
Designed for borrowers building a new home or planning major renovations to their existing dwelling, construction loans carry variable rates and feature an interest-only repayment structure during the construction phase. After the project is completed, the loan reverts to principal and interest repayments.
However, unlike standard home loans, the funds will be drawn down in stages rather than as a lump sum payment.
Advantages of construction loans
Construction loans are generally flexible and have a lot of advantages, including:
The progressive draw-down method of payment for construction loans allows for reduced interest payments and lower interest costs.
Payments are temporarily on an interest-only basis during the construction phase of the home.
Borrowers are protected from substandard work as lenders assess each stage of the construction.
Stamp duty is, most of the time, cheaper as it will only be paid on the land.
Because construction loans are variable rate loans, if rates go up during construction your repayments will also rise. These loans do not allow you to convert to a fixed term during this phase. Since you are only paying interest on the amount you have drawn out, you are not significantly reducing your total debt.
Construction loans are suitable for: As the name implies, this type of loan is suitable for those undertaking major capital works on their property.
Low deposit home loan
A typical mortgage requires a deposit equal to 20% of the target property’s value. Borrowers who were not able to save the typical deposit requirement can apply for a low-deposit home loan instead.
Key features of a low deposit home loan
Low-deposit loans require a minimum deposit of 3% to 5% of the purchase price plus costs. Many lenders accept non-genuine savings, which means you can use gifts in lieu of personal savings. Because you have some equity, Lenders Mortgage Insurance (LMI) is also reduced.
There are also no-deposit loans, which come in the form of 100% and 100%-plus. These do not require genuine savings, and you can use government grants and gifts to offset the costs incurred. With a 100% loan, you are borrowing the entire value of the property but still must pay for the costs involved in buying a home.
A 100%-plus loan enables you to borrow the costs if you do not have enough money to pay for the property and purchase costs, including LMI. Typically, LMI cannot be capitalised on 100% loans and, if it is required, borrowers may need to consider 100%-plus loans.
Advantages of low deposit home loans
Low deposit home loans can help many borrowers who are struggling to come up with a deposit. These are the advantages of this type of home loan:
Borrowers can get into the market sooner as they can apply with a low deposit.
Borrowers can also have guarantors, allowing them to avoid LMI.
Low deposit home loans have the same features as variable home loans.
You will have to take note that the less money you put in upfront, the more you will borrow, and the more interest you will pay in the long haul.
Low deposit home loans are suitable for: Borrowers who want to enter the market sooner, have the ability to meet home loan repayments, but do not have the typical deposit requirement would be able to benefit from this type of home loan.
Low doc home loans
Low documentation home loans are for self-employed individuals who may not be able to provide traditional proof of income like payslips.
Key features of a low doc home loan
Aimed at self-employed borrowers, a low-doc home loan requires far less documentation to prove your income, savings history, and capacity to repay the loan. There are also no-doc loans — these operate in much the same way but differ primarily in the amount of documentation required to convince lenders to write the mortgage.
While low-doc applicants must show evidence of either business or personal income through bank statements or tax returns, no-doc loans operate on the principle of self-verification. A statement signed by you declaring your business income will suffice.
Advantages of low doc home loans
These are some of the major benefits of getting a low doc mortgage:
It provides loans to creditworthy borrowers who are unable to provide full financial documentation to obtain a home loan.
This type of loan is extremely handy for self-employed people who, for whatever reason, would prefer not to disclose the source of their income.
When applying for a low-doc home loan, make sure you state only the income and expenses you have or will declare to the Australian Taxation Office to reduce the likelihood of problems arising from inconsistencies.
Low-doc and no-doc loans may attract higher interest rates, depending on the level of risk perceived by your lender. You may also have to pay extra fees and charges, including 'risk fees'. Low-doc loans of most mainstream lenders also require a clean credit history.
Low doc home loans are suitable for: Self-employed workers would benefit the most from this type of loan. Contract and seasonal workers, or families who have just moved to Australia will also be able to take advantage of this loan.
Line of credit
Line of credit (LOC) is more of a mortgage facility rather than a distinct product. In fact, anyone who has a redraw facility is exercising their line of credit.
Key features of a line of credit
A line of credit allows you to access additional funds by drawing on the equity value of your home. Setting up a LOC involves fixing a limit on how much you can borrow, which is generally a fixed percentage of your loan amount. You direct income from all sources into your LOC loan account and then draw down funds as and when required.
Advantages of a line of credit
A LOC provides borrowers with the opportunity to manage their finances better. Here are some of the advantages of getting a LOC:
You will be able to access extra funds should unforeseen circumstances arise.
Having a LOC is a great way to fund projects where you need access to your funds in stages over time, such as a home renovation.
LOC sounds good on paper but be warned – most come at a price, and a loan feature may not actually pay off financially. If you are not disciplined with your money, you're probably best off not drawing down on your home equity.
LOCs are suitable for: Borrowers who were able to build up equity on their homes or have made a significant amount of extra repayments can benefit from LOCs, as they can access funds that they can use for other big-ticket purchases.
A reverse mortgage is also known as a senior’s loan, which allows borrowers to turn their home equity into cash.
Key features of reverse mortgages
A reverse mortgage is a type of equity release that allows asset-rich, cash-poor Australians — usually retirees — to access funds either in a lump sum, regular income stream, or through a line of credit.
Borrowers aged 60 years and over can borrow 15–45% of the value of your property.
Typically, repayments do not have to be made until the borrower dies or moves into long-term care. Then the loan must be paid out in full, usually out of the proceeds of the sale of the property.
Advantages of reverse mortgages
Reverse mortgages are useful especially for retirees who may be needing access to cash. These are the advantages of reverse mortgages:
It provides access to your home equity, converting it to cash.
You can still live in your own home and retain ownership.
With reverse mortgage payments, you will not end up solely relying on a pension or superannuation policy.
There are several things to keep in mind when taking out reverse mortgages. Reverse mortgages are generally more expensive than traditional loans and can be restrictive. If you are not making regular repayments each month, you're not reducing your debt but accumulating interest. To protect yourself, you need to get a 'no negative equity guarantee' from your lender.
Reverse mortgages are suitable for: Given the nature of reverse mortgages, they are beneficial for retirees who own their home but do not have enough cash for living expenses. It is also worth considering if you decide to look at reverse mortgages as a form of superannuation or paying for retirement.
Non-conforming home loan
Non-conforming mortgages are catered to those who do not meet the mainstream lenders’ strict lending criteria, including people with a bad credit history, a history of late repayments, loan defaults, or possibly even a former bankruptcy.
Key features of non-conforming home loans
Home loans for the credit impaired are in most cases no different from mainstream loans in the variety of choices that are available, such as variable rate and fixed rate. They also offer similar functionalities such as redraw and offset facilities. They are targeted at borrowers who have had credit problems in the past and may have difficulty qualifying for a regular home loan.
Advantages of non-conforming home loans
Here are the upsides of getting a non-conforming home loan:
Borrowers who are otherwise rejected from mainstream lenders due to bad credit can apply for a non-conforming home loan.
Non-conforming home loans are more lenient when it comes to requirements.
One thing you need to consider when getting non-conforming home loans is the higher interest rates lenders charge due to the loan being high risk. Lenders call this the “rate for risk” model, which means that the higher the perceived risk that you may default on your repayment, the higher the interest rate you'll be charged.
Non-conforming home loans are suitable for: Borrowers who are rejected by mainstream lenders can apply for non-conforming loans. Those who have a less-than-perfect credit history and are having some financial difficulties may also find non-conforming loans a viable option.