Home Loans 101

The home loan market is burgeoning with different products, interest rates, packages, features, add-ons, terms, and conditions.

Let's start at the beginning. Here's a simple guide to the main types of loans you're likely to come across:

Home loan types

Variable-rate home loan

Variable-rate home loans are those where the interest rate fluctuated according to the decisions of your lender in response to market conditions.

A typical owner-occupier variable-rate loan is taken out over 25 to 30 years, but one advantage of a variable-rate loan is that you can pay it off sooner by making larger or more frequent repayments.

Fixed-rate home loan

Fixed-rate home loans allow you to 'lock in' an interest rate over a set period of time, generally between one to five years.

These loans are popular among borrowers who want the certainty of knowing their minimum repayments won't rise during the fixed-rate period.

On the downside, that also means they won't benefit from any RBA cash rate reductions that occur in that time.

Borrowers can choose to break a fixed-rate loan but there are costs and penalties that will apply.

Another downside to many fixed-rate loans is that you can't make extra payments on them - or can only make them up to a certain amount during the fixed period.

The rules around this vary according to different lenders and different fixed-rate products so you'll need to research how this could apply to your preferences and circumstances.

See also: How to choose between a fixed-rate or variable-rate home loan

Basic home loan

Many lenders will offer a simple, no frills home loan product - the basic home loan (although it may not necessarily be marketed as such).

These are typically a low interest, low fee, variable-rate loan that usually don't come with too many other features or add-ons like offset accounts (more on these soon) although not always.

These loans are relatively simple to understand. You get approved for a loan amount and you make principal and interest repayments.

Most basic home loans allow you to make extra or more frequent repayments, but some may limit them.

Split-rate home loan

A split home loan essentially allows you to take out a portion of your loan at a variable rate with the remaining portion at a fixed rate.

You can decide how you'd like to split your loan (e.g. 60:40, or 75:25) so you get the predictability of a fixed rate for part of the loan and the benefit of a variable rate for the other.

This set-up allows you to make extra repayments without a cap or penalty on the variable portion of your loan.

Again, it's worth checking with lenders how they charge fees on setting up a split rate loan. Some may charge twice the establishment and ongoing fees for both parts of the loan.

Package home loans

This is a term you may come across when you are researching the home loan market.

Some lenders may offer you a discounted interest rate as part of a package that often includes linked savings accounts, credit cards, and sometimes other products like insurance.

While packaged home loans can provide simplicity for some borrowers, having all their financial products tied to the same lender, not all the products may be offering you the best deals on the market.

Some package loans can also come with annual fees which, in some cases, may account for the discount you are getting on your home loan interest rate.

Be sure to do your figures before you sign up.

See also: What are the different types of home loans?

Other types of home loans not mentioned above can be found near the bottom of this page.

Common home loan features

Here are some loan features that can make a considerable difference to how much your home loan could cost you.

Offset account

An offset account is a transactional bank account that's linked to your home loan.

But the best feature of an offset account is that its balance is deducted from the amount you owe on your loan when interest is calculated.

Simply put, if you have a home loan of $500,000 but have $50,000 in your linked offset account, you'll only pay interest on $450,000.

Often loans with an offset account will come with higher interest rates and fees than, say, a basic home loan with the same lender but a well-used offset account can save you tens, even hundreds, of thousands of dollars in interest and reduce the term of your loan.

Our Home Loan Offset Calculator can give you some idea of how much money and time you can save on your home loan.

Redraw facility

A redraw facility also effectively reduces the amount of interest you pay on a home loan but works in a slightly different way.

Rather than having a linked account where you can keep extra cash, you can pay extra payments into the loan account itself and withdraw them as and when you need them.

Bear in mind, it is only your extra payments you are allowed to access.

Interest is calculated on what you owe so the more extra payments you make, the lower the balance owing will be.

Redraw facilities are typically available on every home loan but can sometimes come with restrictions like minimum withdrawal amounts or limits on how often you can redraw.

Again, you need to check the conditions applied by individual lenders.

See also: What's the difference between redraw facilities and offset accounts?

Now, we've covered some basics, let's look at how you go about applying for a loan.

What is the home loan application process?

The home loan application process can be quite lengthy but isn't too complicated. It will generally involve the following steps:

1. Gathering your required documents

2. Comparing home loan providers (our lender reviews may be able to help you with this)

3. Undergoing a preliminary assessment by your preferred lender

4. Submitting your application to the lender

5. The lender completes a property valuation

6. The lender approves or rejects the loan

7. They send you an offer

8. The loan is settled and the funds are advanced to you

How to get a mortgage pre-approval

Documents needed for a home loan pre-approval

Home loan pre-approval approves you to borrow up to a certain amount, giving you a good idea of what you can and can't afford.

Many buyers will seek pre-approval before they embark on their house hunting journeys so they don't waste time looking at properties they likely won't be able to get loans for.

The documents needed for home loan pre-approval include:

• Proof of income (payslips, tax returns etc.)

• Bank statements and proof of savings

• A list of your current assets and liabilities (e.g. credit card and personal loan debt)

• 100 points of ID (driver's license, passport, Medicare card, etc.)

It should be noted here that getting pre-approved doesn't guarantee your home loan application will be successful.

How long does a mortgage pre-approval last?

Mortgage pre-approval, or conditional approval, usually lasts between three and six months with most traditional lenders. Many don't like to give pre-approvals for longer periods as peoples' financial positions can change, as can the property market.

Getting pre-approved for a loan amount can give you a better idea of your borrowing power and speed up the application process down the track.

How big a mortgage can I get?

Technically, there's no limit to how much people can borrow for a home loan but, of course, how much you can borrow will depend on:

• Your annual pre-tax salary

• Other regular income you receive (rental income, second jobs etc.)

• Your monthly living expenses

• Your regular loan and credit repayments

• Your savings history (see also: Why you need 'genuine savings' when applying for a home loan)

• Your number of dependents (usually children)

• Your marital status

• The type of home loan (owner-occupier, investor etc.)

• The length of your home loan

Different providers will allow you to borrow different amounts, so it's wise to speak to multiple lenders to see which one will be better for you and your circumstances.

Common home loan requirements

Securing a home loan can be a lengthy process, but you can speed it up by knowing in advance what lenders are looking for:

• A home deposit (at least 5%)

• A credit history (a good credit score will improve your chances)

• A stable income (the higher the better)

• No or minimal other debts

• Photo ID (driver's license, passport, etc.)

• Bank statements and payslips

• Council rates for any other properties you own

• Other documents, such as the First Home Owner Grant application or other relevant government schemes

See also:

• Complete Guide to the First Home Guarantee

• Family Home Guarantee: A Guide

• Regional First Home Buyer Guarantee: A Guide

First Home Owners Grant schemes: Criteria

The First Home Owners Grant has different requirements and eligibility details in every state and territory, but the way it generally works is:

• You need to be a permanent Australian resident and at least 18 years old

• You need to buy a new or current house as an individual (not a business entity)

• You must not have used the grant previously

• You must not have owned a home since the year 2000

• You must plan on living in the house for a minimum of six consecutive months

Check your state's eligibility details for more information.

Lenders mortgage insurance (LMI)

Lenders mortgage insurance, or LMI, is an insurance policy that covers the lender for any losses they may incur if the borrower fails to meet their home loan repayments at some time in the future. It is a charge that is typically levied on borrowers with home deposits under 20% of the purchase price and can add tens of thousands of dollars to a home purchase.

Below are some frequently asked questions about LMI:

Is lenders mortgage insurance a one-off payment?

Yes, lenders mortgage insurance is a one-off payment, paid during the settlement of the loan. It is not required to be paid regularly like your mortgage repayments, so you'll need to factor the lump-sum LMI payment into your budget before buying a house.

Although LMI generally applies to borrowers who have less than a 20% deposit, this policy can differ between lenders.

See also: Is it possible to buy a home with no deposit?

Is lenders mortgage insurance refundable?

Lenders mortgage insurance (LMI) is not usually refundable, at least not for loans settled after 2012.

However, there are specific scenarios where you may be eligible for a partial LMI refund of up to 40% of the premium if the loan is fully repaid within a year or up to 20% if repaid within two years.

How can I avoid lenders mortgage insurance?

The best way to avoid paying LMI is to have a deposit of 20% or more. Other ways you may be able to avoid it are:

• Having a guarantor,

• Working in a highly regarded (and highly paid) profession such as a medical doctor, lawyer, or senior accountant can sometimes see some lenders waive LMI

• Looking for special deals surrounding LMI on the lending market

• Using government assistance schemes that facilitate low deposit lending (see above)

Saving for a home deposit

How much deposit is required for a home loan?

Typically, lenders will require you to have a 20% deposit for a home, but some may let you borrow with as little as 5%.

As we've covered, having a 20% deposit can help you avoid paying for lenders mortgage insurance, but with Australian property prices escalating at a rapid pace since the pandemic, many prospective buyers are seeing the magical 20% deposit figure slip further out of reach.

See also: How to save up for a house deposit

Below, we consider some other strategies:

Should I take out a personal loan for a home deposit?

It is possible to get a personal loan for a house deposit, but many providers will be hesitant to accept a borrower without genuine savings. You should only take out a personal loan for a house deposit if you're confident in your ability to repay both at the same time.

Lenders who allow personal loans for deposits will usually require you to have a high income and may charge you a higher rate due to a greater perceived risk.

How to get a 95% mortgage

A 95% mortgage is a home loan where you borrow 95% of the property's value - that means a deposit of just 5%. This type of loan makes it easier for people to save for a deposit, as 5% is significantly less than the standard 20% required by lenders.

However, not all lenders will allow 95% home loans. To get one, you'll need to demonstrate a strong ability to meet repayments since you'll be paying a lot more in interest compared to someone with a 20% deposit. The house you're buying might also need to be reasonably modest (nothing too expensive or fancy).

See also: Which lenders offer 95% LVR home loans?

Other types of home loans

As promised, here are some other more specialised types of home loans that may better suit your needs or circumstances:

1. Low doc (or self-employed) home loans

Low doc home loans, or low-documentation loans, are primarily used by people who have difficulty providing the many documents generally needed to secure a home loan, such as payslips, tax returns, proof of employment, etc.

These types of loans are commonly used by self-employed people, freelancers, or small business owners.

Low-doc home loans can have higher fees and interest rates as well as more restrictive lending conditions, but not always. It will depend on the lender and the level of verification you provide.

2. Guarantee home loans

Guarantee home loans (sometimes called family guarantee or guarantor loans) involve parents using some of the equity in their current property to help their children pay for a home deposit.

Being a guarantor is not a decision that should be made lightly as a guarantor is effectively agreeing to make loan repayments if the borrower can't.

Simply put, if the guarantor can't make repayments either, the lender can take their home to recoup the amount owing on the loan.

3. Construction home loans

As the name suggests, construction home loans are specially designed for people who are building a home.

They tend to have higher interest rates than standard home loans as lenders consider them higher risk. It's also very difficult for lenders to value a home that doesn't exist yet.

Construction loans also tend to come with higher fees and upfront costs and are paid out in stages to the builder directly according to the project's payments schedule.

Generally, borrowers will pay interest only on the loan during the construction process before reverting to standard principal and interest repayments when the home is completed.

4. Equity release or reverse mortgages

Equity release mortgages are also commonly referred to as reverse mortgages. With these types of mortgages, people over 55 can use the equity in their homes to borrow money, either as a lump sum, line of credit, or to provide regular income.

Borrowers don't have to pay any interest on an equity release mortgage, but it does compound over time and continues to be added to the loan balance.

These loans are generally taken out by older people who have an asset, such as their home, but are cash poor and are facing a major expense or cost-of-living pressures.

It is strongly advised you speak to a financial advisor before taking out this type of loan.

5. Low-income home loans

Home loans can be harder to get for low-income families, but not impossible. While there is no such thing as low-income home loans, you can boost your chances of being approved for a home loan by:

• Co-signing with a partner

• Using a guarantor

• Living within your means by applying for a cheaper house

• Choosing a longer loan term (you'll pay more overall but regular repayments will be lower)

• Showing the lender a savings plan with expenses you can cut down on

6. Foreign income home loans

Home loans for foreign income earners are mainly intended for Aussie expats who earn a foreign currency and want to buy a property in Australia. A wide range of banks offer foreign income home loans in Australia, and they will accept a wide range of currencies - you'll usually find a list of these on their website or by asking them.

To allow for exchange rate fluctuations, you might only be able to use 60-90% of your foreign income, so you may still need some form of Australian income (like rental properties) to successfully qualify.

7. Home loans for students

Getting a home loan as a student is tough because lenders are quite strict on their income requirements. They will assess your ability to meet monthly interest repayments on a home loan but as a student, you're unlikely to be earning anywhere near enough to get a home loan without some serious savings.

If you want to buy a house as a student, you'll need to save up for a deposit. As well, a deposit of less than 20% of the property's value will attract lender's mortgage insurance.

8. Home loans for single parents

Getting a home loan as a single parent is difficult but not impossible. Lenders assess household income, so only having one income instead of two will make it harder to get approved for loan.

Lenders will also assume you'll have a harder time meeting monthly loan repayments. However, they do see Centrelink payments and Government Childcare Benefits as income.

Make sure you also check out the federal government's Family Home Guarantee scheme which provides low deposit loans to eligible single parents or legal guardians of dependent children.

9. Relocation home loans

Relocation home loans, also known as bridging home loans, are loans for people who have bought a new home and are in the process of moving. This loan is used to 'bridge' the time between settlements, providing funds for you while you sell your current house using the equity in your home.

Most bridging loans last up to six months for existing homes or 12 months if you're constructing a new home.

10. Rural home loans

Rural home loans can be used for rural property designated as a 'hobby farm' - that's farming for personal reasons and not commercial. However, any land that returns more than $20,000 is considered income-producing and may not qualify. Some lenders will also see larger parcels of land, typically over 100 hectares, as 'income-producing' even if it's not being used to generate income.

Some lenders will allow you to borrow up to 95% of the land's value (100% with a guarantor) but may not offer a loan for land greater than 10-15 hectares.

If you're a first home buyer looking to purchase a home in a regional area, it's also worth checking out the federal government's Regional First Home Buyer Guarantee scheme.

Researching the market

Before your sign up to any home loan, it's wise to do your research. A mortgage broker can help you clarify your position and provide a range of home loan options that may best meet your needs.

Generally, brokers have arrangements with specific lenders and typically receive commissions for every home loan they initiate. That said, brokers are also legally required to work in the borrower's best interest or risk incurring major penalties.

It's a good idea to understand the basics of how home loans work, the terminology, and a general idea of what rates are available in the market before you meet with your bank, broker, or other lender so you're able to make the best decision for your circumstances.

The table below may be useful in giving you an idea of some of the most competitive interest rates on the market:

Important Information and Comparison Rate Warning

Image by Vitaly Gariev on Unsplash

---

---