Buying a home is the most important purchase of your life. Whether you’re looking for your first or next home to live in or use as an investment, it’s natural to have questions and be confused.
Applying for a home loan can be intimidating, but if you do it right, it’s a life-long reward. A home loan is a long-term debt, so understanding what it is and how it works can save you from stress and unnecessary costs.
No need to get lost going back and forth between banks and lenders. We break down everything you need to know about home loans.
What is a home loan?
It’s possible to purchase a property without getting a home loan. But let’s be real. Homeownership is an expensive dream, so many Australians can’t buy a home outright – enter home loans.
A home loan is a type of loan where you borrow money to purchase a property. Remember that the loan is secured against the home itself, so the lender can take possession of the property if you fail to pay your loan.
Is the loan amount all you need to pay? Sadly, no. Aside from the loan you take out, you should also pay the interest charged on your loan. The interest rate varies per lender and type, and it is affected by different factors, such as the official cash rate set by the Reserve Bank of Australia.
You and your lender can agree on how long your loan term will be and how often you will repay the loan (weekly, fortnightly or monthly). Typically, home loans can last for 25 to 30 years. But believe it or not, there are some things you can do to pay off your loan earlier.
Is there a difference between a home loan and a mortgage?
If you’re considering a home loan, you may get confused about how it’s different from a mortgage. These two terms are often used interchangeably, but they are not 100% the same. So, let’s draw the line between them.
A home loan refers to the money you borrow to finance a property. On the other hand, a mortgage is a legal agreement between you and a lender wherein the property acts as the security for the loan. This means they may repossess and sell the property in case you default on your loan.
How much is a home loan deposit?
Usually, lenders require at least a 20% deposit when you get a home loan in Australia, so you borrow 80% of the property’s value. But this is not a hard rule – some lenders allow you to borrow up to 95% although you may need to pay Lender’s Mortgage Insurance (LMI). You pay the LMI, but it is a type of insurance that protects the lender and gives them the confidence to let you borrow more.
A deposit under 20% (also known as low deposit home loans) is considered high risk, so you need to meet stricter eligibility criteria. If you’re a first home buyer, some schemes allow you to deposit 5% (sometimes, even lower) without paying LMI. So, this gives you a leg up the property ladder. To help you estimate how much you can borrow, you can easily use our borrowing power calculator.
How does a home loan work?
Other than your deposits, you should also understand what your repayments will look like. When you get a home loan, you can choose between principal and interest and interest-only repayments.
The loan principal refers to the actual amount you borrow, and the interest is the cost charged by your lender. So, as the name suggests, a principal & interest loan means your repayments cover the principal and the interest.
On the other hand, an interest-only loan allows you to only pay the interest for an agreed period. But keep in mind that your repayments will be higher when the interest-only period ends because you will start paying the principal and interest. If you want to have an idea of your repayments, you can use our loan repayment calculator to gauge your ability to make repayments.
What is a home loan pre-approval?
A home loan pre-approval (also known as conditional approval) indicates that a lender agrees to lend you a certain amount for your home loan. But this is not a formal or unconditional approval, so nothing is final yet. A pre-approval is not a requirement, but it has its perks.
Getting a pre-approval is a smart move because it helps you know your maximum borrowing power. This way, you know how much you can afford, you can narrow down your search and you can confidently make an offer on a property.
What does the comparison rate mean in home loans?
If you’ve been browsing home loans, chances are you’ve seen something called a comparison rate beside the advertised interest rate. This rate includes the interest rate and other fees and charges related to a loan. It is calculated based on a $150,000 secured loan with a 25-year term.
The comparison rate gives you an idea of the overall cost of a loan. Lenders are required to show you this rate to help you compare loans and decide which one works for you best.
What do you need to qualify for a home loan in Australia?
Different banks ask for different requirements. Usually, these are the documents that financial institutions require for a home loan:
Proof of identity
- Current passport
- Driver’s license
- Proof of age card
- Birth certificate
- Medicare card
- Credit card
- ATM/debit card
- Healthcare card
- Citizenship certificate
Proof of income
- Copy of two most recent payslips
- PAYG summary
- Personal and business tax returns
- Notice of assessment for the last 2 years from the Australian Taxation Office (ATO)
Assets and liabilities
- Bank statements showing genuine savings (usually 3 months)
- Bank statements from the account you do your spending from (usually 3 months)
- Credit card statements (if applicable, usually 3 months)
- Details of any existing loans, such as personal or car loans
- Supporting evidence if other funds contribute to your home loan deposit (e.g. family guarantor or monetary gift)
- Share investment statements
- Term deposit statements
- Superannuation statements (if applicable)
- Contract of Sale for the property you are buying
Remember that your lender may ask for more documents depending on your situation and loan. So, preparing them ahead of time can make your loan application easier and faster.
What are the different types of home loans?
Now that you know how home loans work, you should also understand your choices. This will help you find the right loan that suits your goals and situation and plan your repayments. There are different types of loans, but these are the 3 standard types of home loans based on interest rates:
Fixed rate loans
As the name implies, this loan locks your interest rate for a certain period (typically 1-5 years). Fixed rate home loans tend to have a higher interest rate, but they offer security as you are protected when the interest rate rises. When your fixed rate period ends, you can refix your loan, stay on the revert rate or move to a variable rate.
Fixed rate loans are for people who want certainty. Because you get a fixed interest rate for an agreed period, it provides secured repayments. So, you get peace of mind, and you can budget easier.
But the downsides are that you cannot reap the benefits of lower repayments if the interest rate falls. Also, you may have limited access to loan features and pay extra fees if you break your fixed rate before the agreed period.
Variable rate loans
With a variable rate home loan, your repayments fluctuate as the interest rates rise or fall over the life of the loan. This loan relies on the RBA’s official cash rate and the lender’s discretion. Your rate may move unpredictably, but a variable rate offers flexibility.
Variable rate loans go well for borrowers who want to access loan features (e.g. offset account and redraw facility) and make extra repayments without cost. Offset accounts and redraw facility can help reduce the amount of interest you pay on your loan, so these are great features you may consider when choosing your loan.
But this loan yields uncertainty as your rate is based on the RBA’s changing cash rate. This means your budgeting can take a toll if the rates change aggressively.
To get the best of both worlds, you can split your loan. With a split home loan, you can fix a portion of your loan and dedicate the remaining portion to a variable rate. Plus, it doesn’t have to be 50:50, so you are free to divide your loan however you like.
For example, if you have a loan of $500,000, you can fix the rate on the $200,000 and keep the $300,000 as a variable rate. This way, you enjoy the certainty of your fixed portion and the flexible features of your variable rate.
There are also some common types of home loans based on purpose:
Owner-occupier home loans
If you intend to purchase a home to live in, this is the loan for you. An owner-occupier loan allows you to borrow to buy an existing home or build a new property. Because you occupy the property yourself, you do not rent it out as an investment.
Guarantor home loans
If your parents own a property, you can apply for a guarantor home loan. A guarantor is a direct or immediate family member (usually parents) who allows you to put the equity in their property as security for your home loan.
This means that your guarantor is responsible for your loan in case you fail to meet your home loan repayments. To minimise the risk, your guarantor can only guarantee a portion of the loan.
Investment home loans
Whether you’re a first-time or professional investor, investment home loans allow you to borrow money to buy an investment property. This loan tends to have higher interest rates compared to owner-occupier loans, and you need to meet stricter criteria depending on your lender’s requirements.
But the good thing with investment loans is that you can claim tax benefits through negative gearing. Negative gearing happens when your investment income is less than the cost of your investment. Then, you can claim this net loss against your total taxable income, so you reduce the tax you pay.
Low-doc home loans
A low documentation loan can vary per bank, but it’s perfect for people who are self-employed or freelancers. This loan is designed for those who have income and assets but don’t have the usual required documents (such as payslips, proof of employment, etc.) for a standard home loan.
If you’re planning to build a home or make major renovations, you can apply for a construction loan. Instead of paying a lump sum, the lender makes progressive payments throughout the stages of the construction. The stages vary, but they usually include building the foundation, framing, locking up, fixing and completion.
With a construction loan, usually, you only pay interest on the amount drawn down. This means that if you’ve drawn down $120,000 from a $500,000 loan, you only need to pay the interest on $120,000. Then, you will switch to principal and interest repayments when the construction finishes.
If you want to buy a new house but haven’t sold the one you’re currently living in, a bridging loan is for you. This is a short-term loan (usually an interest-only loan) to help you cover the cost of purchasing the new property while you sell your current home. In a way, it acts as a bridge between buying and selling.
While this seems promising, remember that this is an additional loan you take on top of your current home loan, so you pay 2 loans at the same time. Plus, a bridging loan comes with a limited term.
Refinancing home loans
Technically speaking, there is no one loan for refinancing. But refinancing your home loan means you replace your existing mortgage with a new loan. You may refinance either with your current lender or a new one.
There are many reasons to refinance, but you may choose to do so to switch to a lower interest rate, access home loan features, tap into your equity or consolidate your debts. When you’re looking to refinance, make sure that you switch to a better deal to make it worth it.
Line of credit loans
If you already own a property, you can borrow against your existing equity. In simpler terms, equity is the value of the property you already own. Home equity is the difference between your home’s current market value and your outstanding loan balance:
Property value: $500,000
Outstanding balance: $250,000
Raw home equity: $250,000
But remember that you can’t access the maximum of your equity. A line of credit loan allows you to borrow up to the pre-arranged limit. Plus, you get to access the funds when you need to.
To work out how much of your equity you can borrow against, calculate 80% of your home’s current value minus your outstanding debt. This gives you your usable equity.
For example, your property’s value is $500,000, and you still owe $250,000. Your usable equity is $150,000:
$500,000 x 0.8 = $400,000
$400,000 – $250,000 (outstanding debt) = $150,000
A reverse mortgage is designed for borrowers aged 60 and over. With this loan, you can draw on a portion of your usable equity and convert it to cash. Depending on your lender, you can take it as an income stream, line of credit or lump sum.
While a reverse mortgage allows you to retain ownership, remember that your debts increase and your equity decreases over time. But the good thing is you can choose to make repayments in part or in full at any time.
Want to secure your home loan?
Home loans can be confusing and stressful with all the paperwork and negotiations involved. But if done right from the get-go, it is a lifetime of reaping rewards. To loan with comfort and confidence, book your FREE consultation now.
If you need help finding, reviewing or applying for a home loan, It’s Simple Finance’s mortgage brokers are always here to help you. We will evaluate your goals and situation, find the right loan options for your circumstance and help you secure it.