How different types of home loans work
With so many different home loans out there, it's hard to know which one is best. We've gone through our various home loans to help you work out which one is right for you.
Your home loan options are more adaptable and personalised 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 a fixed rate.
Principal and interest repayments
Principal and interest repayments are the favoured option for most people. Each payment reduces your principal (the amount you initially borrowed) as well as the interest charges. Over time you start paying off more and more of the principal. The best aspect of this loan is that your home is building equity, so you could use that equity to invest.
These 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).
If you only make repayments that cover the interest portion, 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.
We have a more detailed explanation and case study to help demonstrate the differences in our article about interest-only versus principal and interest repayments.
Australian Securities and Investments Commission, opens in new window has some useful information for customers interested in using an interest-only repayment period as part of their loan term. Check out their MoneySmart, opens in new window guidance for some easy to follow infographics highlighting the pros and cons 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.
What are the standard types of home loans?
Variable rate loans
With a variable rate loan, your repayments vary depending on when the interest rate rises and falls. If rates go up, your repayments do as well. If rates go down, your repayments may 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 a 100% offset which is an account that offsets your loan balance, which can reduce the amount of interest you pay on your loan. This facility isn't offered with fixed rate loans.
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 finishes, you may opt for another fixed rate period, or move to a variable rate.
The advantage of a fixed rate loan is you have the certainty of knowing exactly how much your repayments will be. Effectively, you're opting for security and certainty over flexibility. This helps with budgeting, but the main 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 certainty of fixed repayments, but also want features like a 100% offset, then this loan is for you. A split loan is part fixed and part variable, so you get the best of both options.
You will 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. If interest rates rise, you'll be better off than if you'd taken out a variable rate loan only. If they were to fall, you're better off than if you'd gone just with a fixed rate.
We know that the home loan process can be daunting. When the time comes, don’t feel like you need to do it on your own. If you’re ready to get started you can book an appointment online with a home loan expert.
Owner occupier vs residential investor loans
These are two terms you’re likely to see when selecting a home loan or when reviewing interest rates.
Owner occupier means the person or persons living in the home own the home.
A residential investor is someone who purchases a residential home (not commercial or business property) for the purpose of renting it out as an investment.
Interest rates may differ depending on the loan type you’re choosing.
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The information contained in this article is intended to be of a general nature only. It has been prepared without taking into account any person’s objectives, financial situation or needs. Before acting on this information, NAB recommends that you consider whether it is appropriate for your circumstances. NAB recommends that you seek independent legal, financial and taxation advice before acting on any information in this article.
Target Market Determinations for these products are available at nab.com.au/TMD.