Your home loan options are more adaptable - and more personalised - today than ever before. You may prefer a shorter duration loan - with higher repayments - or pay a little less, for longer. You may opt for the flexibility of a variable rate, or for the certainty of fixed rate.
We'll look briefly at the pros and cons of paying principal and interest versus interest only, then look at our main types of loan (and who they work best for).
Principal and interest repayments
The favoured option for most people. Each payment reduces your principal (the amount you initially borrowed) as well as covering the interest. Over time you start paying off more and more of the principal. The best aspect of this loan? Your equity's edging up from the start.
Interest only repayments
Repayments cover only the interest portion of your loan, which can offer tax advantages for people with investment properties. At the end of your interest only period, you’ll need to start paying off principal (unless you apply for another interest only period).
While making repayments that only cover the interest portion means smaller repayments during the interest only period, you'll end up paying more interest over the life of the loan (which might be 30 years). Our loan repayments calculator will show you how much extra interest you’ll pay on an interest only loan.
Australian Securities and Investments Commission has some useful information for customers interested in using an interest only repayment period as part of their loan term. Check out their MoneySmart guidance for some easy to follow infographics highlighting the pitfalls and benefits of this type of lending structure. You can also find examples of how much you may expect to pay for this type of loan structure.
Line of credit
Think of this as a giant overdraft which uses your house as security and lets you take out money as you need to. You pay interest only on what you use, not the total credit limit.
An example? Let's say you're approved for a $150,000 line of credit to cover renovations. In the first month you use $25,000 to pay tradespeople—and so you pay interest on just this $25,000. In the second month you use another $70,000 for building materials—and so you're now you pay interest on the new balance of $95,000. This continues until you reach your $150,000 credit limit.
What are your standard 'types' of home loans?
We have three.
Variable rate loans
With a variable rate loan, your repayments vary depending on interest rate rises and falls. If rates go up, so do your repayments. If rates go down, your repayments fall too. These can be a good option in a lower interest climate such as Australia has experienced since 2009.
An important feature of variable rate loans is that you're able to make extra repayments—without cost—to pay off your loan sooner. You also have the option of 100% offset which you don’t get with a fixed rate loan.
Fixed rate loans
The interest rate on this loan is fixed for a certain period—usually one to five years (or up to 10 years for investment properties). When that period's up, you may opt for another fixed rate period, or else move to a variable rate.
The big advantage of fixed rate loans is that they offer certainty—you know exactly how much your repayments will be. Effectively, you're opting for security (and certainty) over flexibility. This obviously helps with budgeting. But the chief downside is that you won’t get the benefit of lower repayments if interest rates fall. Also if you break your loan before the fixed term expires, you could incur economic costs.
If you like the the certainty of fixed repayments, but also want features like 100% offset, then this loan’s for you. Part fixed, part variable.
How does it work? You have two smaller loans equalling your total loan amount. You might borrow $300,000 in total, but fix $200,000 and keep $100,000 as variable. Think of this as a hedge—if interest rates rise, you'll be better off than if you'd taken out a variable rate loan only. Conversely, if they were to fall, you're better off than if you'd gone just with a fixed rate.