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How Do Home Loans Work?

Are you thinking about buying your first house? If you are, then it’s highly likely that you’ve been wondering how loans work. Buying your first home and taking out your first mortgage can be daunting. But it doesn’t need to be.

Armed with the right information (and some professional advice; make sure you check with your financial adviser), you’ll have a handle on how home loans work in no time.

What is a Home Loan?

A home loan (also known as a mortgage) is an advanced sum loaned to you—usually by a bank or major financial institution—to purchase a property.

The loan is secured against the property you’re buying. So, in the event that you can’t make your repayments, then the bank can sell the property to collect any debt still owed.

A home loan requires that you not only pay back the amount borrow to purchase your property, but also any interest, fees and charges. Interest charges can fluctuate, depending on a whole range of market factors, as well as the terms and conditions of your bank. We go into more detail about interest, fees and charges below.

In Australia, a home loan is usually paid back over quite a long period—perhaps 25 or 30 years—with repayments made either fortnightly or monthly.

Interest Rates

When it comes to interest rates, there are two key terms you should know:

  • Interest rate:This is the actual rate of interest that your bank will charge you per annum. To calculate your fortnightly or monthly repayments, your bank multiplies the interest rate by the loan principal. For example, if the interest rate is 2% and you owe $500,000, the interest you will need to pay per annum is $10,000.
  • Comparison interest rate (also known as the APR):This is basically the entire sum that you will need to pay. So, it includes the interest rate (as outlined above), plus all the fees and charges. 


Doing your research regarding fees is important. Fees can vary quite a bit between lenders. In particular, make sure you understand the costs associated with the:

  • Account keeping fees
  • Annual fees
  • Redraw fees
  • Application fees

Types of Home Loans

There is a whole range of different types of home loans. The type that is most suited to you and your family will depend on several factors. As such, it is important to do your research before committing to anything.

Fixed Rate Home Loan

If you opt for a fixed rate home loan, it means that the interest rate you need to pay remains fixed—it will not change for the period of the loan. This period is usually between one and five years (not the entire term of the loan). Fixed rate home loans can be beneficial – they ensure that have some certainty as to the exact repayments you’ll need to make (at least in the short-term). Although, they can be a bit inflexible at times.

Variable Rate Home Loan

A variable home loan is almost the exact opposite of a fixed rate home. With this type of loan, the interest rate changes, in line with market conditions. These types of loans are quite flexible, but they just don’t have the same predictability of payments.

Split Home Loan

Are you keen for a mortgage that is both flexible and provides certainty around your repayments? A split home loan could be the one for you. With this type of loan, a portion is ‘fixed’ and a portion is variable—it makes for a nice middle ground.

Interest-Only Home Loan

As the name suggests, with an interest-only loan, you just pay the interest. You don’t pay off the principal. Usually, interest-only is capped at certain length of time. This type of loan offers cheaper monthly repayments, and can be good if you’re planning to sell the property within a few years.

The key is to do your research, compare the entire sum over the length of the loan to find the best deal for your circumstance.

Sally Writes 05 Dec 2020