Types of Home Loans

Fixed rate (principal and interest) loans

Making principal and interest (P&I) repayments, helps to trim the principal (or ‘capital’), as well as the mortgage interest on the home loan. That said if you select a P&I option, your repayments will be higher than if you make interest-only payments.

A P&I option can be a smart choice if you intend to live in the property for a long time. By paying off the capital, you not only increase your own equity stake in the property, but this strategy will result in outright home ownership. Moreover as you pay down the principal, you'll simultaneously help to reduce the interest you'll pay over the term of the loan.

Interest-only home loans

On an interest-only loan, you only pay the mortgage interest set by the lender, which means you don’t pay off any of the capital. Most lenders offer interest-only loans for a limited time – up to 5 years in some cases – after which you either need to start paying back the principal, or you must reapply to continue paying the home loan on an interest-only basis.

Introductory loan

These are sometime referred to as ‘honeymoon’ loans because of the honeymoon period during which you pay a discounted interest rate – often the cheapest on offer – for an initial period of time. The discounted period is usually 12 months, though some lenders offer the discount for as little as six months or for up to three or four years.

The introductory rate can take one of two forms, the first being a ‘fixed discount’ and the second being a ‘discounted fixed’ rate. The fixed discount is a rate that will be variable, but fixed at a certain level or margin below the standard variable rate. This means that for the introductory period, the discounted rate will move with the market. If the standard variable rate rises by, say, 0.50%, so will the discounted rate, and if the standard variable rate drops by 0.50% the discounted rate will also drop. The discounted fixed rate, on the other hand, is a rate fixed for the introductory period of the loan, and won't move with the market

Line of Credit Loan

A line of credit home loan allows you to borrow money up to a specified limit, repay that amount and then borrow up to the limit again numerous times.

Such a mortgage operates similar to a credit card – you draw down as much as you need and then pay it back.

There are two options to choose from:

Principal and Interest Line of Credit

A P&I loan has a reducing balance, meaning every dollar goes towards paying down your home loan sooner, saving you years of payments on your loan and thousands of dollars in interest.

The benefit of this option is that you avoid the common trap with a Line of Credit where you don’t pay down the principal and find yourself still owing the full loan amount 10 years into the home loan.

Interest Only Line of Credit

where the home loan credit limit remains constant for the 10 year interest only period on this fully transactional line of credit.

The benefit of this option is that you can use the equity in your home for an investment property, shares or other personal uses.

Low-doc loans

Low-documentation or low-doc loans are for people - generally the self-employed - who have difficulty getting the documentation together that is required to get a traditional home loan.

Low-doc loans differ from another relatively new loan in the marketplace that is also gaining popularity a non conforming loan. Low-doc loans have become very popular over the past few years and industry figures state they comprise around 10 per cent of all mortgage loans written.

Traditionally, the interest rate offered on these types of loans was higher than for the standard variable rate but recently they tend to be offered at similar rates. While lenders have various methods of establishing whether they will lend someone money, there are some major differences between mainstream and low-doc loans.

Non conforming loans

Non-conforming loans on the other hand are mortgages that do not conform to a lender's typical loan underwriting criteria. This may include situations where the applicant has a poor credit history, or who may not have been employed long enough to show a history of earning an income.

Non-conforming loans may exceed 80 per cent of the security's value and the interest rate is based on the severity of the credit history.

Split rate (principal and interest) loans

Anyone with a passing familiarity with home loans - or loans in general, for that matter - will be aware of terms like ‘fixed interest rate’ and ‘variable interest rate’. Less famous (or infamous, depending on your point of view) are terms like ‘split home loan’, ‘split facility’ and ‘split mortgage’.

All of them mean the same thing. They describe a home loan arrangement where you can have both fixed and variable interest rates on your loan at the same time. Essentially, you split your home loan into portions and allocate an interest rate model to each one. You may wish to only have a fixed interest rate on 20% of your loan, for example, while you pay the variable rate on the remaining 80%. How you divide the split facility is up to you.

The 'split loan' option is typically viewed as a comfortable compromise between the pros and cons of fixed and variable interest rate loans. A split mortgage allows you to reap the benefits of both the security of fixed rate loan and the flexibility of a variable interest rate loan.

They’re particularly effective when the market is proving harder than usual to predict. If you don’t know if interest rates are going to go up or down, a split home loan allows you to hedge your bets a little. If they go up, you’re tied into the lower current interest rate. If they go down, you’re in a position to take advantage of those lower rates.

No home loan is risk-proof and every one is different – but a split home loan might be a good way for you to avoid some of the pitfalls of the house-buying market. 

Variable (principal and interest) loans

The rate charged on a variable loan moves up or down in accordance with movements in interest rates, as set by the Reserve Bank. However, your lender is at liberty to change rates at their own discretion and this may be due to the cost of funds. Basic variable loans generally have fewer loan features than a standard variable loan. Basic variable loans are suitable if you are looking to pay off a consistent amount over the full term of the loan, but are not suitable if you are looking to pay off your mortgage quickly.