Home loan types and features
The language used to describe loans can be confusing. For those preparing to enter the property market, or are still unclear on how certain loan types work, we have created a ready reckoner to help you identify what each loan type is and how it works.
Variable rate loan
This is a home loan where the interest rate varies whenever the lender makes a change. These may be in line with changes in the official rate made by the Reserve Bank of Australia. A change in the rate will result in an increase or decrease in the amount of your repayments.
This is a home loan where the interest rate is locked in for a specified period of time (commonly 1, 3 or 5 years). This gives you certainty of your repayment amount, however, these loans have restrictions on making extra repayments, having offset accounts and can have huge break costs, so be sure to speak to us about your needs.
This loan type allows you to split your loan – for example, part variable and part fixed. In this instance you can have a combination of the security of a fixed interest rate and the flexibility of a variable interest rate. Some lenders also let you split your loan into two accounts which can be useful if the loan is used for various purposes – for example, part owner occupied and part investment.
Principal and Interest (P&I)
This is a loan where the repayment covers both interest charged on the outstanding balance plus an amount that will repay your loan. Each month, the size of the loan slowly reduces until there is no further debt.
Interest only (IO)
This repayment type allows you to only pay the interest charged on your loan each month for the first few years, after which it reverts to principal and interest. The total principal loan balance remains the same and your debt does not reduce during this time. This is often used by property investors as it maximises tax deductions and the repayments are lower than if they were principal and interest. The period of interest only payments is typically 5 years, but can be as high as 15 with some lenders.
Loans with this feature allow borrowers to make payments over and above the minimum monthly repayment. This can be either as one-off (lump sum) or ongoing additional payments. Making extra repayments reduces the amount of interest charged and results in you paying off your loan sooner. This option may be limited or not allowed on some loans, particularly those with fixed rates.
Redraw gives you access to any additional repayments you have made into your loan. Loans with this feature allow you to withdraw any surplus funds from your loan without having to go through the loan application process. It is important to note that if you draw out surplus money, you will be automatically charged interest on the higher loan balance.
Offset account – Watch video
This is a transaction account that is linked to a home loan. The balance of the funds in the transaction (or offset) account reduces the balance of the home loan resulting in lower interest being charged on the loan. Over time, savings in the offset account can help you pay your home loan off more quickly and build up equity in your property. Offset accounts are most beneficial for investors who can preserve their future interest deductions as explained in the video.
Line of credit
This type of loan allows you to borrow against the equity in your home. It is the equivalent of an overdraft facility and you can draw as much or as little as you need so it is very flexible. You only pay interest on the amount of money you actually use and the loan limit remains in place so as you pay back the loan, you can re-borrow the funds again. Line of credit loans are commonly used by investors as they have access to funds without the need to apply for additional loans and also provide a buffer fund for any unexpected expenses.
Also known as a ‘pro pack,’ this is a discounted home loan package offered by many lenders to borrowers with a total home loan amount above a predetermined level. There is usually an annual fee of $300 to $400 but in return you have access to a discount on your home loan rate plus upfront and ongoing fees are usually waived. In addition, most professional packages come with an offset account which can help you reduce the interest charged on the loan, and a fee-free credit card is also common.