Property is an obsession for many in Australia, representing not only a place of shelter but a hugely valuable form of investment. According to the Australian Bureau of Statistics (ABS), the Australian property market is worth a staggering $11 trillion as of late 2024.
Yet the great Australian dream of owning your own home has never been tougher, with high property prices making it challenging for a generation of renters to get onto the property ladder. In Demographia’s annual list of housing affordability across 94 major markets, Sydney was ranked as the second-most expensive city globally in 2024, beaten only by Hong Kong. Melbourne came in seventh.
Those who manage to purchase a home often take on eye-watering mortgages. According to the ABS, the average Australian home loan as of June 2024 was $636,597, while in New South Wales it was $780,028 on average. During the pandemic, interest rates fell to as low as 2.5% but after the Reserve Bank of Australia’s (RBA) rate-hike spree, they are at 6% or even higher.
Understanding how home loans are structured in Australia is crucial to finding a mortgage that matches your needs. Let’s take a closer look at how they work.
Recent History of Australian Home Loans
Obtaining a home loan is a lengthy process, and meeting the lending criteria of a bank or credit union requires plenty of documentation.
But the process wasn’t always this way. Before the global financial crisis of 2007-2008, Australian banks began offering ‘low-doc loans’ to those who had trouble obtaining a mortgage, and by 2004, it is estimated that some 10% of home loans were made up of these risky products.
The 2007 subprime mortgage crisis in the US, and the global crash that followed, prompted tighter lending restrictions in Australia and put an end to bad credit mortgages and low-doc loans.
In 2017, the Australian Prudential Regulatory Authority (APRA) took issue with the market dominance of interest-only loans favoured by investors, which are cheaper than principal-and-interest loans. At the time, there was a huge influx of investors who were purchasing properties via interest-only investor loans and flipping them for profit.
At one point, some 60% of loans within the Sydney market were held by investors rather than first home-buyers or downsizers. The APRA ruled that lenders must cap interest-only lending at 30% of their total loans.
Banks and lenders further raised their game in the wake of the 2017 Hayne Royal Commission into Banking, which found several institutions guilty of unethical lending practices. Since the commission’s recommendations, mortgage brokers must act in the borrower’s best interests or face a civil penalty.
The Covid-19 pandemic initially depressed house prices and loan commitments, but as government financial stimulus flowed to households and the Reserve Bank of Australia (RBA) slashed the official cash rate to 0.1%, there were very few mortgage defaults. Instead, spurred on by cheap money, the Australian property market grew by 32.5% per cent between March 2020 and February 2024, according to CoreLogic figures.
Different Types of Home Loans
There are several types of home loans to choose from, depending on your circumstances.
Investor Loans
Investor loans are for landlords who intend to rent their properties to tenants. Many of these properties are negatively geared—that is, the cost of servicing the mortgage is more than the income generated. Negatively-geared properties are popular among landlords as they can claim a loss on their tax return and receive negative-gearing tax concessions.
As investor loans are generally considered higher risk than owner-occupier loans, they attract a higher interest rate.
If as an investor you decide to move into your investment property, you must live there for a certain length of time before you can refinance to a cheaper owner-occupier loan. These rules stem from the APRA regulations of 2017, which attempted to rein in high levels of investor activity.
Owner-Occupier Loans
If you’re a first home-buyer or a down-sizer, chances are you have an owner-occupier loan.
These are considered less risky than investor loans as they apply to the borrower’s principal residence rather than a rented-out asset. As a result, the interest rates are lower than investor loans, and the lending criteria are often less rigorous.
Construction Loans
Designed for those building a home or renovating, construction loans allow borrowers to draw down the loan at various stages of the build in what are known as ‘progress payments’.
While the house is being constructed or renovated, borrowers only need to pay interest on the loan, rather than principal and interest, although you can often pay off extra to reduce the debt sooner.
The risk with construction loans is that you borrow too little to cover the build cost, as most projects feature some degree of cost blow-out.
Paying Off Principal and Interest
Loan repayments comprise two parts: the principal, which is the amount borrowed, and the interest you pay on that amount.
Most owner-occupiers take out a principal and interest loan as this allows you to pay down the debt from the outset and spread the cost of your repayments evenly across the life of the loan.
Interest-only loans, by contrast, involve paying off just the interest for a set period of time to minimise your repayments. These loans are popular among investors who routinely purchase a property, pay off the interest for a number of years, then sell the property once the market has risen. This allows them to, ideally, make a profit from capital growth without paying down the principal.
Since the investor boom a decade ago, APRA has cracked down on these kinds of loans, restricting the number of interest-only loans lenders can write up each year.
While interest-only loans may seem like a great way to minimise your repayments, it’s important to remember that the interest-only period ends eventually, and you will need to pay back the principal over the remainder of the loan, which means a large jump in repayments. The Commonwealth Bank, for example, limits its interest-only loans to five years before mortgage holders must switch to principal-and-interest for the remainder of the loan.
However, interest-only repayments can be a lifeline for those facing financial hardship or unemployment. By switching to interest-only, borrowers can minimise their repayments until they are in a better financial position before resuming paying off both the principal and interest.
Home Loan Features Explained
Home loans have evolved into complex financial instruments with a range of features.
Fixed vs Variable
Variable interest rates change in line with the movements of the RBA cash rate. If the RBA raises interest rates, banks also raise rates on mortgage products. If they cut rates, your mortgage interest rate should also be reduced – although the reduction you see in your rate may not be as big as that made by the RBA.
Fixed rates, on the other hand, lock in an interest rate at a certain point and offer peace of mind for those who don’t like surprises. Typically, the fixed period lasts between one and 10 years, meaning your repayments won’t change during this time. It also means that you won’t be subject to a huge increase in your mortgage if the cash rate rises, but nor will you reap the rewards of lower interest rates if the RBA goes on a rate-cutting spree.
If you are having trouble deciding between the two, some banks will allow you to split the loan so that a portion of your mortgage is variable while the rest is fixed. This allows you to have the best of both worlds.
Redraw Facility
Many lenders offer a redraw facility as part of the home loan package, which allows you to pay off extra on your loan and either draw on that money down the track if you need it, or ask your bank to absorb the redraw into your loan so that you pay off your mortgage sooner.
Offset
An offset facility is a sub-account within your mortgage that allows you to ‘offset’ the interest you pay against the savings you deposit. If, for example, you have a loan of $300,000 and $30,000 of money in the offset account, you will only be charged interest on $270,000.
Many Australians park their savings in an offset account when interest rates are high to minimise repayments. Some offsets are free, while others incur a small monthly fee as part of the home loan package.
Loan Terms
Most home loans are between 15 and 30 years in length. While a few lenders offer 40-year loan terms, this is rare.
It’s wise to select the shortest repayment period possible, as you will pay less interest in the long run.
What Is Loan to Value Ratio?
Before you secure a mortgage, you will likely need to come up with a deposit. In most instances, banks require a 20% deposit, so if, for example, you’re looking to buy a home for $800,000, you will need a deposit of $160,000.
Most lenders use the Loan to Value Ratio (LVR) test to determine your borrowing capacity. LVR is calculated by dividing the loan amount by the property’s value.
Taking the above example, the LVR would be calculated as follows:
- Borrowing: $640,000 ($800,000 minus the $160,000 deposit equals $640,000)
- Divided by $800,000
- Equals 80% LVR.
The lower the LVR, the better, as it means you have a larger deposit and, therefore, need to borrow less. You can have an LVR higher than 80% and still qualify for a home loan, but you may need to pay Lenders’ Mortgage Insurance (LMI), which aims to protect your lender if you default on your home loan.
The federal and various state governments recognise that half the battle in buying your first home is saving up the deposit. To help first home buyers enter the market, there is a range of schemes and discounts available, including:
- The First Home Guarantee Scheme enables eligible first-time buyers to purchase a home with a 5% deposit, with the National Housing Finance and Investment Corporation (NHFIC) guaranteeing up to 15% of the property’s value to make up a standard 20% deposit.
- The Family Home Guarantee allows single parents to purchase a home with a 2% deposit, with the federal government guaranteeing the remaining 18%.
- The First Home Super Saver Scheme (FHSSS) allows first home-buyers to make before- or after-tax contributions into their superannuation fund, which they can access later for their home deposit.
There is also a raft of stamp duty discounts available for first home-buyers in various states and territories. You can read more about these in our guide.
What To Look For in a Home Loan
Everyone’s needs differ, so a perfect home loan for one person may not suit another. Nevertheless, there are a few key points to remember when researching home loans.
- What is the interest rate? If you have a low LVR, or are refinancing from an existing home loan and have a reasonable amount of equity in your home, you should be able to attract a competitive interest rate.
- What is the comparison rate? The comparison rate represents the true cost of the loan: the interest rate and additional fees, including monthly fees. While a lot of home loans have no monthly fees, some, especially those with additional features, will charge a small fee. If the comparison rate is much higher than the interest rate, this means there are significant fees that will add to the cost of your loan.
- Does the loan offer the features you’re looking for? Are you interested in an offset or redraw, and if so, will these be free? Also, if you’re not interested in these loan features, make sure you’re not paying for them unnecessarily.
- What will my monthly repayments be? It’s important to make sure you’re comfortable making these repayments. Also, ask yourself whether you could manage repayments if interest rates were to rise.
Working With a Mortgage Broker
Mortgage brokers remain popular among Australian borrowers, with 74.6% of all new home loans written by mortgage brokers in September 2024, according to the latest data from the Mortgage and Finance Association of Australia (MFAA).
One of the main advantages of working with a mortgage broker is that they act as an intermediary between you and the lender, arranging the documentation on your behalf and ensuring the lender’s criteria are met.
It’s uncommon for borrowers to pay for a broker; instead, the broker receives a payment from the lender for signing up a new customer as well as a trailing commission each year for the life of the loan. (While the Hayne inquiry recommended brokers be banned from receiving commissions over the life of a home loan, then-Treasurer Josh Frydenberg stopped short of implementing this measure.)
Some brokers are paid more for offering certain loans, so it’s important to ask your broker how many mortgage products they have in their portfolio and whether they are paid the same for each recommendation. If your broker only recommends a handful of products, this may inhibit your chances of getting the best home loan.
Consumer group CHOICE also recommends that, before you engage the services of a broker, you check they are registered on ASIC’s Professional Registers Search.
