A short guide on different types of home loans in the market

When you take out a home loan, one your first choices will be deciding between a fixed or variable interest rate. But what does that mean?

When you take out a variable rate mortgage, the interest you pay can change at any time. This is often based on changes to the official cash rate set by the Reserve Bank of Australia (RBA), though mortgage lenders can also raise or lower their variable interest rates out of cycle from the RBA.

A variable rate home loan may offer more financial flexibility than a fixed-rate home loan, and you might be able to pay less or build equity faster if interest rates fall. On the other hand, you must also be prepared for rate hikes.

Borrowers who want more certainty around their repayments may prefer a fixed-rate mortgage, where you make your repayments at a fixed interest rate for a specified period, often up to 5 years, before it reverts to the lender’s standard variable rate. This keeps your repayments consistent for a limited time, so you can confidently plan your budget in advance.

Keep in mind that fixed rate home loans are often less flexible than variable rate options, and watch out for bill shock at the end of the fixed term – if variable rates have risen in the meantime, you may revert to a much higher interest rate, significantly increasing your repayments.

You can purchase a property to make it your home or use it as a rental to supplement your income. Depending on how you intend to use the property, you can choose between an owner-occupied or investor loan, both of which come with different sets of features and rates.

Owner-occupied home loans are available to borrowers who plan to live in the home they’re financing. You can take out an owner-occupied loan to purchase an existing home or construct a new property, including buying off the plan. Both fixed and variable rate options are available, and these loans are typically principal and interest loans, where you repay a portion of the principal along with interest charged on the outstanding amount each month.

An investment loan, on the other hand, is used to finance a property you won’t live in - at least initially. You may be able to choose to only pay the interest on the loan, leading to smaller monthly repayments and better cash flow. However, you must remember that the interest-only period is for a limited time of up to 5 years in most cases, and your repayments will jump considerably once that period is over.

When you take out a typical mortgage, you receive the money you require to buy the property at the start of the loan term as a lump sum. On the other hand, a construction loan is structured to pay you money in instalments to finance the various stages in the construction process. Instead of receiving a lump sum, you only draw down the amount you need to lay the foundation, build the frame, and so on at each subsequent milestone until the house is built.

Usually, the loan is structured in a way that you only pay interest while the house is being built and only on the money you’ve drawn down so far. This minimises your repayments until the construction is complete when the loan reverts to a traditional principal and interest loan.

A bridging loan is a short-term financing solution used to ‘bridge’ a brief gap in funding, such as to finance a new property when the old one hasn’t sold yet.

Usually these loans are interest-only with a limited duration, up to 12 months, and used to manage the repayments for a new property until your existing home is sold.

Lenders require multiple documents to verify your income when applying for a home loan, like your recent bank statements and payslips. However, self-employed individuals, freelancers and small business owners might struggle to provide the standard proof of income documentation required for a traditional home loan.

If you are one of these borrowers, you may be able to apply for a low doc loan that doesn’t require standard documentation for approval.

Instead, you’ll be asked to provide alternative income proof like:

• Two years of personal tax returns;
• Business activity statements (BAS);
• Profit and loss statements;
• An accountant’s letter verifying your financial position.

Note that low doc loans often have higher interest rates, but they can help you get a foothold in the property market if you’re a non-traditional borrower. You may later be able to refinance to a regular home loan at a lower rate if the required documentation becomes available.

Some lenders offer home loans to self-managed super funds (SMSFs) to purchase investment properties. The returns on the investment property, whether rental income or capital gains, are channelled into the super fund to grow the retirement savings of the trustees.

Much like SMSFs themselves, these home loans are often highly regulated, and may not be well-suited to all borrowers, as they may require specialist knowledge and expertise to manage while fulfilling the tax office’s requirements. 

If you’ve had credit issues in the past, your poor credit score could make it harder to successfully apply for a mortgage. You may be able to apply for a bad credit home loan with a non-conforming or specialist lender, which will assess your application after listening to your side of the story.

However, you must convince the lender you can repay the loan and that a mortgage will help improve your financial situation (if you’re looking at debt consolidation) to get approved for a home loan with bad credit.

If you’re aged 60 years or over and are looking for a way to fund your retirement without selling your home, a reverse mortgage on your home might be an option.

A reverse mortgage is structured so that you can continue living in the house after borrowing money against it without making any repayments. However, if you pass away or move out, the property is sold to repay the lender.

All home loans are different, and the best mortgage for you depends on your circumstances, future plans and how you intend to use the property. It helps to remember a mortgage is a long-term agreement that can affect your lifestyle and finances.

For more personalised advice, you may need to contact a mortgage broker to discuss your requirements in detail.