- Repayment options can include principal and interest, or interest only. The former refers to both interest payments and paying off a portion of the home loan itself.
- Variable home loans may come with various features such as an offset account, redraw facility, and more.
- Home loan discounts can appear when banks are looking to achieve a particular goal.
The ears of Australian home owners and prospective buyers likely pricked up when the Reserve Bank of Australia (RBA) decided to continue its hold on the cost of borrowing at its latest meeting this month.
The official cash rate stayed at 4.35%, seeing many borrowers wiping another bead of sweat from their brow, but as for a sigh of relief? It looks more like bated breath given the uncertain outlook ahead; services inflation was singled out as a key point of uncertainty.
At the Reserve Bank of Australia’s (RBA) latest meeting, interest rates were held at 4.35%, but it was noted that inflation continues to decline at a slower pace than expected; forecasts currently have Australia reaching the target range of 2% to 3% within the latter half of 2025 and halfway through 2026.
With growing numbers of Aussies looking to buy, The Property Tribune sat down with Subiaco-based Gemma Ward, a mortgage broker with Aussie Home Loans, to decode the home loan lingo and explore some of the common mistakes made by borrowers.
Table of contents
- The difference between interest only, and principal and interest
- The difference between variable rate and fixed rate loans
- Types of variable rate home loans
- Common mistakes
- How long does a home loan last?
- Breaking down the jargon
Interested in interest? And what’s a principal?
Those in the Australian housing market will typically see the following two terms bandied around: principal and interest, also shortened to P&I; and interest only, sometimes referred to as IO.
Principal and interest loans are where each repayment comprises both a portion of the principal amount borrowed and the interest charged on that principal.
Interest only loans only require repayments of the interest charged on the loan amount for a set period without reducing the principal.
What are the pros and cons of P&I and IO loans?
Gemma explained that principal and interest loan repayments, “… will gradually reduce the size of the loan. You’re going to end up owing the bank less and building equity into your home.” Additionally, you could be paying less total interest compared to an interest only loan.
P&I rates also tend to be lower than IO rates, according to Gemma. This is because “… the lenders want to encourage people into P&I loans.” We explore that more shortly.
On the flip side, repayments for a principal and interest loan are of course higher than interest only loans.
Also a drawback is reduced cash flow, meaning you’ll have less disposable income each month due to those higher repayments.
Interest only loans will initially see lower repayments because you are not paying off the principal on the loan.
For some, this means they can free up cash to go towards other expenses during the interest only period.
The drawbacks of the IO loan include no growth in equity – meaning you’re not reducing the loan balance during the interest only period.
Other cons include higher costs in the long term, meaning you’ll be paying more interest over the life of the loan if you don’t start paying off the principal.
Why are interest rates on P&I lower than IO?
Over the past few years, a lot has changed. While interest only loans were very common across the preceding decades, Gemma told The Property Tribune that a significant issue arose among older borrowers.
“There were older clients on interest only loans who headed into retirement not having paid off their loan and not having enough equity to access and be able to retire.
“So, they changed the rules around that and priced things accordingly, making P&I repayment rates more attractive.”
These days, Gemma noted that from a lending point of view, borrowers need to justify why they were choosing interest only loans.
“For investment lending, it’s entirely reasonable that you go interest only, whereas if it is on your principal place of residence, there has to be a really good reason for doing so.”
Gemma said for the latter, it could be on financial advice or due to a change in circumstances.
What’s the difference between a variable rate and fixed rate loan?
As the name suggests, a variable rate loan has an interest rate that can fluctuate over the life of the loan. A fixed rate loan, will lock in that interest rate for a certain period, typically one to five years.
Pros and cons of variable rate and fixed rate loans
A variable rate loan means you can benefit from a lower rate if interest rates fall. Of course on the flip side, if rates rise, then repayments also rise.
Variable rate loans often come with features like offset accounts and redraw facilities.
Budgeting, however, may be more difficult, as payments may fluctuate.
Fixed rate loans, on the other hand, help people to lock in a particular rate, making budgeting easier. Those fixed repayments also lend some people peace of mind, as there is predictability when it comes to their finances.
The cons can include reduced flexibility compared to variable home loans; there may be limits on making extra repayments or refinancing.
And of course, if rates fall, then you’ll be stuck with a higher rate and therefore higher repayments.
Can I do both?
A split rate loan divides your loan, allowing you to allocate a portion to a fixed rate, and the remainder to a variable rate.
Is there more to know about variable home loans?
Generally speaking, in Australia, we have two types of variable home loans: a standard variable rate, and a ‘no-frills’ or basic variable rate.
These are typically differentiated by the rate you pay and the features that are available to you.
What you need to know about a standard variable rate
As the name suggests, Australian home buyers borrowing on a standard variable rate can expect to see the interest rate on their home loan change. The standard variable rate home loan in Australia often comes with the full suite of features such as offset accounts, redraw facilities, and the ability to make extra repayments – often at lower to no cost compared to other types of loans.
The obvious drawback is that you will bear the cost of any rate rises; the standard variable rate also tends to be higher than other variable rate loans.
Can I get a discount?
A discount may be offered as an incentive for new customers, Gemma told The Property Tribune.
A mortgage broker might also be able to help bargain for a bigger discount, however, this varies significantly from lender to lender.
“Very generally, those are package variable rates, which means you pay a monthly or annual fee to get that extra discount and features,” said Gemma.
Where’s that discount coming from?
Going into some of the context first, Gemma explained different lenders have different rates because of a very complex calculation. While she is not a banker and cannot speak to the details of that calculation, she noted that the crux of it is the cost of borrowing for the banks themselves, i.e. where the banks are finding the funds to lend it to a consumer.
“Also, as part of the governance with APRA, each lender is required to have a balanced loan book. There are benchmarks set for lenders that mean they have a certain number of owner occupied loans, investment, interest only, variable versus fixed, high loan to value ratio (LVR) versus low LVR, and so on,” said Gemma.
“What we find over time is, when a lender sees a gap in their balance loan book, they will release ‘specials’ to attract that type of business.”
“For those introductory rates, a lot of them are for low LVR clients. That’s because that bank wants to attract those clients and they do it by their interest rates.”
Can I get a simpler option than the standard variable rate?
The ‘no-frills’ or basic variable rate loan tends to offer the lowest interest rate of the two types of variable home loans. This is done, unsurprisingly, by offering fewer features and less flexibility than the standard loan.
“The discount is loaded at the top end,” said Gemma.
“We cannot ask for any change in that discount.”
She added, “While there are no extra features, it also means there is no ongoing fee for that.”
It is possible to switch to a home loan with more features, Gemma noted, “… and you just start paying that fee.”
Common Australian home loan mistakes
The most common mistake Gemma has seen is borrowers not accounting for extra costs; she added that the number of people making this mistake is shrinking.
“Everybody knows you need to pay stamp duty when you buy a house, but not everybody knows that there are other costs involved when buying your own home.”
“You need a settlement agent, conveyancer, or solicitor to perform settlement on your behalf; there are government fees and charges, such as title transfer and for registering the mortgage onto that title; and there are other fees and charges like enquiry fees and title search fees.
“On the day of settlement, the buyer may also need to reimburse the seller for any prepaid fees that they’ve paid on that property, for example, land rates.
“Rates usually come out in August or September every year. For example, if you’re settling your home in November, and the seller has already prepaid the rates from November to June of the next year, the buyer needs to reimburse the seller.”
“Not accounting for those funds is a very common mistake.”
“I see it a lot, especially when applicants go directly to the bank. Clients come to me to refinance and consolidate a personal loan that the bank has forced them to take out because they’ve had a shortfall at settlement.
“Luckily, most of the time, the value of the property has gone up, so we can consolidate that.
“The reason we don’t use the word deposit is because the term is misleading; you need all funds for all those other expenses, that’s why we use the term funds to complete.”
How long does a home loan last?
A standard loan term is 30 years, however that can change depending on the circumstances.
What does all the feature jargon mean?
Some of the common features you’ll find on an Australian home loan include redraw facility, offset account, portability, and more.
Redraw facility
The redraw facility is one way you can reduce the interest paid on your home loan. This is done by making extra repayments beyond the minimum required home loan repayment.
This facility also enables you to take out those extra repayments, hence the name redraw. Once redrawn, however, it no longer helps to bring down the interest you’re paying on the home loan.
Offset account
This feature is a separate transaction account linked to your home loan.
Why is it called offset? The balance of the offset account is offset against your home loan balance, which reduces the amount of interest you pay.
For example, a $300,000 mortgage with $50,000 in an offset account will only see interest charged on $250,000.
“Because of daily compound interest, every day you have more money in your offset account, the more you save in interest,” said Gemma.
She added that the main difference between a redraw and offset is functionality.
“The net outcome of a redraw and offset is the same: saving interest,” said Gemma, however, the redraw facility requires the borrower to make transfers between accounts, while an offset account with a debit card means that they can transact like normal.
Portability
Standard variable rate loans may come with the option to transfer your loan to a new property if you decide to sell your current home and purchase a new one.
What’s AAPR and how does it differ from a comparison rate?
Gemma told The Property Tribune that the average annual percentage rate, or AAPR, is a more comprehensive comparison than the comparison rate.
“We don’t use the comparison rate because it doesn’t compare apples with apples, it compares apples with oranges, whereas the AAPR compares apples with apples and over a longer period of time.”
“The comparison rate only does it over two years, while the AAPR does it over seven years.”
Extra repayments
These two words aren’t jargon, as such, but a feature of the standard variable loan. Furthermore, for a standard variable loan, it is typically allowed without penalty. Broadly speaking, basic variable rate loans and fixed rate loans are much less flexible with extra repayments.
A low or no penalty extra repayment feature essentially provides the borrower with the flexibility to increase repayments if extra funds become available.
Flexible repayment options
With a standard variable rate loan, you may have the flexibility to choose your repayment frequency (e.g., weekly, fortnightly, or monthly) and adjust the amount of your repayments. This allows you to align your repayments with your income schedule and budget, making it easier to manage your finances.
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