Georgia Rose
Alan Hartstein
Mary Flory
A mortgage, or home loan as they’re often called, allows buyers to pay for a property over time. After several years, mortgage owners repay the money they borrow with interest and own the property outright once the loan is paid off. Buying a house may be the biggest single purchase or investment you make in your life. So, before signing on the dotted line, it pays to understand the basics.
What is a mortgage?
A mortgage is a loan agreement between a lender and a buyer used to purchase a residential property. You (the buyer) repay the loan in instalments over a set period of time, usually 20 to 30 years. The length of the loan can be shorter or longer, depending on the amount you borrow, among other factors.
Home loan vs. mortgage
The terms mortgage and home loan generally mean the same thing: They both describe the loan buyers take out to purchase a property. However, there’s actually a slight difference between the two terms.
- A home loan is the money borrowed to buy a house or property.
- A mortgage refers to the legal loan agreement between the borrower and the lender.
Despite this semantic distinction, you can usually use the terms interchangeably. In this article, we treat both terms as the same.
How do mortgages work in Australia?
Mortgages are similar to other types of loans, such as a car loan: You borrow money to pay for the item and pay it back over time. However, there are unique elements to a mortgage that are worth understanding.
House deposit
When you use a mortgage to buy a house, the lender (a bank or financial institution) typically requires a 20% deposit for the loan — called the house deposit. This deposit pays off some of the loan upfront and reduces the risk to the lender. It also allows you, the buyer, to avoid paying LMI (Lenders Mortgage Insurance). LMI is a type of insurance that lenders require if the deposit is under 20%. Deposits over 20% are typically not subject to LMI.
Principal and interest
Aside from closing costs and additional loan fees, mortgage payments are made up of two parts: Principal and interest.
The principal is the base amount of the loan. For example, if you buy a house for $500,000 and pay a 20% deposit ($100,000), $400,000 of principal is owed on the loan.
Interest, however, is the cost of borrowing money. The lender charges interest on the amount you borrow over a set period of time, taking into account the loan amount and your credit history, among other factors. In July of 2023, the average interest rate on owner-occupier home loans was 5.89% (fixed and variable combined), according to the Reserve Bank of Australia data.
Mortgage term length
Home loans can vary in length, but most range from 20 to 30 years, with a few reaching 40 years.
The longer the home loan, the more interest you’ll pay. Therefore, try to secure a mortgage with the shortest term length you can afford.
🤓 Nerdy Tip
There are ways you can pay off your mortgage faster, such as making fortnightly payments.
Home equity
As you repay your mortgage, you’ll start earning equity in the property. This is your home’s current value minus the remaining loan balance. For example, if your home is valued at $500,000, and you’ve got $200,000 left on your mortgage, you’ll have roughly $300,000 in equity. Remember, equity does not indicate ownership — it simply refers to the value of the home that you’re entitled to.
Property ownership
When you have a mortgage, you don’t own the property until you repay the loan in full. In the simplest form, the lender pays the seller for the house, and then you repay the lender.
The lender can take possession of the property if you cease to make the required repayments and default on your mortgage. If this happens, they typically sell the property to recoup their money. If the sale price does not satisfy the amount due on the loan, you may be on the hook for the difference.
Refinancing
As a mortgage holder, you can refinance your home loan, either with your current lender or a new one. Reasons to refinance include getting a better interest rate or adjusting the term length of the loan. Keep in mind that your lender may impose break costs if you pay off the loan early.
Selling
Even if you have not paid off your mortgage in full, you can still sell your home at any time. However, as with refinancing, you may incur break costs if done early. Break costs are avoidable by porting the mortgage to the new property (if this option is available).
Mortgage interest rates
Lenders charge interest on the home loan, which you pay over the mortgage term. The interest rate reflects the amount of interest charged by the bank. It determines how much you’ll pay the lender in exchange for borrowing the money.
As you repay the loan, usually fortnightly or monthly, a portion of each payment goes towards the interest. Therefore, your total mortgage repayment figure includes the principal (the amount you’ve borrowed from the lender), the interest (the amount the lender charges you to borrow the money) and any other applicable fees.
Fixed vs. variable rate mortgage
How much interest you pay depends on your rate and whether you have a fixed or variable loan.
Fixed-rate mortgage: A fixed interest rate stays the same for a set period of time, usually up to five years.
Fixed loans can help with short-term budgeting, as they provide you, the homebuyer, with certainty regarding your repayment commitments.
However, after the fixed term is up, your payments can go up (if interest rates are high). Similarly, if rates drop during that time, you’ll be stuck paying the higher amount until the end of the fixed period.
Variable rate mortgages: A variable home loan has a constantly changing rate — most mortgages in Australia take this form. As discussed above, you may start with a fixed rate, but these almost always move to a variable rate after a relatively short period.
Variable home loans typically provide less certainty as rate changes aren’t predictable.
Split home loans: Some lenders offer a partially fixed rate. They break up your mortgage into two parts — say 50/50 — and you pay a fixed rate on one portion and a variable rate on the other.
Types of home loans
Choosing the best type of home loan for you depends on your financial circumstances and personal goals. To make this important decision, make sure you understand how home loans vary.
- Owner-occupier home loan. As the name suggests, this type of loan is for buyers who plan to live in the property.
- Guarantor home loan. This type of loan allows a third party, often a close family member, to use the equity in their home to cover some of the deposit.
- Investment home loan. In contrast to an owner-occupier loan, an investment loan is for properties that you intend to use as an investment, not your home.
- Low doc home loan. This type of loan does not require the same extensive income documentation as standard mortgages. Self-employed buyers, for example, may benefit from this type of loan as the process for providing proof of income is more flexible.
- Reverse mortgage. If you’re 60 years old or over, you can access the equity in your home by taking out a reverse mortgage. Typically, the loan is repaid when you sell or move out of the home or your estate settles it after death. Interest rates for reverse mortgages are often higher than standard loans, so talk with a fee-only financial adviser before proceeding.
- Construction loan. You can finance your home renovations through a construction or building loan. The money is paid directly to the builders as work is completed. Term lengths and interest rates vary between lenders.
- Bridging loan. If you want to buy a new home before selling your current one, a bridging loan can help you ‘bridge’ the gap. You typically have to repay the bridged loan within a year or so. Therefore, this loan is only practical if you know you can sell your current home fairly quickly.
- Home equity line of credit. In some cases, you can take out a line of credit against the equity in your home. Like a credit card, a home equity line of credit is revolving, so you use the credit only as needed.
- Interest-only mortgage. Instead of repaying both principal and interest from the start, this type of loan only requires interest repayments for the first few years. The initial payments tend to be lower than standard loans, but you’ll pay more interest in the long run. Plus, after the interest-only period is up, you’ll start to pay both principal and interest. If unprepared, this may be a financial strain.
🤓 Nerdy Tip
Check out Australia’s many first-time homebuyer schemes to help you get on the property ladder, such as the First Home Owners Grant (FHOG).
How to get a mortgage
Before you start looking for a home, it’s a good idea to suss out how much you can borrow.
To do this, the lender needs to assess your financial situation.
First, they verify your personal details, such as your name, address, citizenship or permanent residency, and age.
Next, you need to provide detailed information about your finances to determine your ability to repay the loan.
Home loan eligibility requirements
Finally, to determine whether you qualify, the lender will factor in your credit report and score and assess three chief factors.
- Income and expenses will show how much money you have coming in on a regular basis and how much you can therefore afford to borrow. The lender will want to see things like your bank account statements and paychecks.
- Employment history to establish a pattern of financial stability. This depends on your type of employment but usually entails providing payslips and a record from your employer. If you are self-employed, a freelancer or a contractor, you’ll likely need to provide proof of regular income through bank statements, tax returns and possibly a letter from an accountant.
- Assets and liabilities include anything of value you own and any existing loans and credit card debts. Assets usually include term deposits, savings accounts, cars, shares and even jewellery. It’s in your interest to talk to your lender if you’re unclear about what to include in your loan application.
Once you satisfy the eligibility requirements, the lender will pre-approve you to borrow a set amount of money. Now you can start the house hunt.
Once you find a home, the lender assesses the property’s value, considering a range of factors, including its size, age, condition and location.
Next, they compare your deposit to the property’s value and arrive at the loan-to-value ratio (LVR) for your mortgage. If your deposit is less than 20% of the property’s total cost, you may have to pay LMI.
Finally, you’ll receive final or unconditional approval for your mortgage and can start the process of buying your new home.
First Home Buyer Tips: 5 Mistakes To Avoid
Enlisting early help from a lending professional, doing neighbourhood-level research, and factoring ongoing costs into your budget are some key tips for first-time home buyers to consider.
Should I Refinance My Home Loan?
You should consider refinancing your home loan when the new loan offers a lower interest rate with better terms.
How To Find A Mortgage Broker
You can find a mortgage broker by searching the MFAA or FBAA databases, or getting recommendations from trusted friends and family.
Understanding Your Mortgage Amortisation Schedule
A mortgage amortisation schedule shows how you’ll pay off your home loan over time, typically monthly for up to 30 years, and how much principal and interest you’ll pay.