Types of Home Loans – Pros and Cons

Here is a quick snap shot of the differences between each type of home loan – their advantages and disadvantages.

Loan Type Advantages Disadvantages

Fixed rate (principal and interest) loans

A loan with a fixed interest rate and fixed loan repayments. Time period varies between 1-5 years. The total length of the loan may be 25 or 30 years, and the fixed rate period may be 3 years.

• Repayments do not rise with official interest rate
• Makes accurate budgeting possible
• At the end of the loan period, you may either get another fixed loan at current market rates or convert to a variable interest rate for its remaining duration
• Early loan payout is penalised
• Repayments do not fall with official interest rate
• Additional payments are limited

Interest-only home loans 

During the term of the loan, only the interest on the principal is repaid. Principal and Interest are paid over the remaining loan term.

• Repayments are lower than standard principal and interest loans
• Lower repayments mean that your funds may be allocated elsewhere, like your principal place of residence
• The cost of buying a residential investment property in the short-term is cut
• Repayments will increase abruptly at the end of the Interest Only period
• Lenders will assess your ability to repay the loan only on the principal and interest repayments, reducing your borrowing power

Introductory loan

Offers a low interest rate (or honeymoon rate) initially, usually for about 12 months. At the end of the low interest period, rates usually revert to the standard rate.

• Ideal for borrowers who are initially low on budget
• Rates may be fixed or capped
• The principal can be reduced quickly with payments at the introductory rate
• An offset account against these loans may be provided, depending on the lender
• Payments increase after honeymoon period

Line of credit loans

Allows access to funds in times of need and revolves around equity built up in your property. Cash is provided up to a pre-arranged limit and, on a monthly basis, the loan account balance is reduced based on cash coming in and increased by the amount of cash withdrawn or paid on the credit card.

• Lower home loan interest rates, usually
• A flexible option
• Typically higher interest rates, compounded by a monthly interest-only payment as a minimum
• Can potentially reduce equity in your residential property
• Requires discipline
• Can be very expensive if the balance of the line of credit is not regularly reduced.

Low-doc loans

Allow for fully serviceable loan options and redraws, and requires only minimal supporting documents.

• No tax returns or financial reports are required; all that you need is an income declaration form
• Ideal for self-employed borrowers or investors for refinancing, purchasing or renovating purposes
• Higher interest rate

Non-conforming loan

A loan offered by lenders who are less strict about borrower’s previous credit issues.

• Ideal for people with poor credit ratings • Larger deposit and higher interest rate than traditional loans
• Lenders typically require evidence of your ability to pay the loan

Split rate (principal and interest) loans

A loan that is part fixed and part variable.

• Allows for more accurate budgeting than a full variable loan
• Additional payments on variable portion are possible
• Eases concerns about rising rates
• Repayments will rise when official interest rates rise
• Limited additional payments

Variable (principal and interest) loans

Interest rates for variable loans closely follow upward or downward movements in official interest rates (i.e. as set by the Reserve Bank).

• Basic variable loans are ideal for paying off a consistent amount over the full loan term.
• Standard variable loans come with additional features and more flexibility; ideal for paying off mortgage quickly by eliminating the penalty for advanced payouts.
• Repayments are lowered when official interest rates fall
• Repayments will rise when official interest rates rise.
• Basic variable loans are not ideal for quickly paying off mortgage.
• Basic variable loans have fewer loan features than standard variable loans.