Types of Mortgages Explained

Common Types of Mortgages

1. Variable Rate Loans

Variable rate loans are the most common type of mortgage in Australia. With these loans, your interest rate can go up or down, depending on market conditions. 

In March 2024, the average variable interest rate for owner-occupiers was around 5.1% [citation:1]. The beauty of variable rate loans is the flexibility they offer. You can make extra repayments or pay off your loan faster without any penalties.

However, the downside is that your monthly repayments can change, making budgeting a bit trickier. If interest rates rise, your repayments will increase, which could put a strain on your finances. On the flip side, if interest rates fall, you could enjoy lower repayments and save money in the long run.

Pros:

• Flexibility to make extra repayments without penalties.
• Potential to benefit from lower interest rates if the market rate decreases.

Cons:

• Monthly repayments can vary, making budgeting more challenging.
• Risk of higher repayments if interest rates rise.

2. Fixed Rate Loans

If you prefer stability and predictability, a fixed rate loan might be the way to go. With this type of mortgage, your interest rate is locked in for a set period, usually between one to five years. This means your monthly repayments will stay the same, no matter what happens to interest rates in the market.

Fixed rate loans can be a great option if you’re on a tight budget or if you believe interest rates are likely to rise in the near future. They provide peace of mind and make it easier to plan your finances. However, there are some drawbacks to consider.

Firstly, if interest rates fall, you won’t benefit from the lower rates. You’ll be stuck paying the higher fixed rate until the end of your fixed term. Secondly, fixed rate loans often come with restrictions on extra repayments and redraw facilities. If you want to pay off your loan faster or access your extra repayments, you might face fees or penalties.

Pros:

• Predictable monthly repayments make budgeting easier.
• Protection against rising interest rates.

Cons:

• No benefit from lower interest rates if market rates drop.
• May incur fees for extra repayments or early termination.

3. Split Rate Loans

Can’t decide between a variable rate and a fixed rate? A split rate loan could be the perfect compromise. This type of mortgage allows you to split your loan into two portions – one with a variable rate and one with a fixed rate.

For example, you might choose to have 60% of your loan at a variable rate and 40% at a fixed rate. This way, you can enjoy the flexibility of a variable rate loan while still having some protection against interest rate rises.

Split rate loans can be a good option if you want the best of both worlds. You can make extra repayments on the variable portion of your loan and have some certainty with your monthly repayments on the fixed portion.

Pros:

• Balance of predictability and flexibility.
• Potential to make extra repayments on the variable portion.

Cons:

• Complexity in managing two different interest rates.
• Limited benefit from fully variable or fully fixed rate advantages.

Mortgages for Specific Situations

1. First Home Buyer Loans

Buying your first home is an exciting milestone, but it can also be daunting. The good news is that there are specific loans and government incentives designed to help first home buyers get into the property market.

In Australia, first home buyers make up about 30% of the market [citation:2]. Many states and territories offer grants and stamp duty concessions to eligible first home buyers. These incentives can provide a significant financial boost and make it easier to afford your first home.

Incentives:

• Government grants such as the First Home Owner Grant (FHOG) offering up to $10,000.
• Stamp duty concessions in various states and territories.

When looking for a first home buyer loan, it’s essential to compare your options and find a mortgage that suits your needs. Some lenders offer special discounts or waived fees for first home buyers, so it’s worth shopping around.

2. Investor Loans

If you’re looking to purchase an investment property, you may want to consider an investor loan. These loans are specifically designed for people who want to buy a property for investment purposes, rather than to live in themselves.

Pros:

• Potential tax benefits, such as deductions on interest payments and depreciation.
• Ability to leverage rental income to qualify for higher loan amounts.

Cons:

• Higher interest rates compared to owner-occupier loans due to increased risk.
• Stricter eligibility criteria, requiring evidence of rental income or potential rental income.

Investor loans often come with higher interest rates compared to owner-occupier loans, as they are considered higher risk by lenders. However, they may also offer tax benefits and other features that can make them an attractive option for investors.

When applying for an investor loan, you’ll need to provide evidence of your rental income or potential rental income, as well as your own financial situation.

Lenders will also consider factors such as the location and type of property you’re buying, as well as your experience as an investor.

3. Low-Doc Loans

If you’re self-employed or have a unique income situation, you may find it harder to qualify for a traditional mortgage. This is where low-doc loans can be a useful option.

Pros:

• Flexibility in income verification, accepting bank statements or accountant’s letters instead of payslips.
• Tailored for self-employed individuals or those with fluctuating income.

Cons:

• Higher interest rates and fees due to perceived higher risk by lenders.
• More limited loan options compared to traditional mortgages.

Low-doc loans are designed for borrowers who may not have the usual documentation required for a mortgage application, such as payslips or tax returns. Instead, lenders may accept alternative forms of income verification, such as bank statements or accountant’s letters.

While low-doc loans can be a good solution for some borrowers, they often come with higher interest rates and fees compared to standard mortgages. This is because they are considered higher risk by lenders.

4. Refinancing

If you already have a mortgage, refinancing could potentially save you thousands of dollars per year. Refinancing involves taking out a new loan to replace your existing mortgage, often with a lower interest rate or better features.

According to the Australian Bureau of Statistics, around 20% of mortgage holders refinance their loans each year [citation:3]. By securing a lower interest rate, borrowers can save between $1,000 to $5,000 annually [citation:4].

Pros:

• Lower interest rates can significantly reduce monthly repayments.
• Opportunity to switch to a mortgage with better features or terms.

Cons:

• Costs associated with refinancing, such as valuation fees, application fees, and potential break costs.

When considering refinancing, it’s important to weigh up the costs and benefits. While you may be able to secure a lower interest rate, you’ll also need to factor in any fees and charges associated with refinancing, such as valuation fees, application fees, and break costs if you have a fixed rate loan.

5. Specialised Loans

There are also a range of specialised loans available for specific situations, such as:

Bridging loans: 

These short-term loans can help you buy a new property before you’ve sold your existing one. They allow you to “bridge” the gap between the two transactions.

• Purpose: To help you buy a new property before selling your existing one.
• Interest Rates: Typically higher, ranging from 6% to 8%.
• Loan Terms: Short-term, usually between 6 to 12 months.

Rural loans: 

If you’re looking to buy a farm or rural property, you may need a specialised rural loan. These loans take into account the unique features of rural properties, such as seasonal cash flow and the value of livestock and equipment.

• Purpose: For purchasing agricultural land, equipment financing, and rural property purchases.
• Interest Rates: Generally range from 4% to 7%, slightly higher than urban loans.
• Loan Terms: Typically span from 10 to 30 years.

Construction loans: 

If you’re building a new home or doing major renovations, a construction loan can provide the funds you need in stages, as the building work progresses.

• Purpose: For building a new home or doing major renovations.
• Funding: Provided in stages as the construction progresses.