How Do Home Loans Work?

A home loan, often referred to as a mortgage, is money borrowed from a lender to help purchase a property. You repay this loan over time with interest, usually for 25 to 30 years. For many Australians, a home loan is the largest financial commitment they’ll ever make, so it’s crucial to understand the basics before diving in.

We’ll break down the basics of how home loans work, from repayments and interest to loan types and what lenders look for during the application process. If you’re already considering your borrowing options or want tailored support, our mortgage advice services can help you get started.

What Is a Home Loan?

A home loan is a secured loan that allows individuals or families to buy residential property. The loan is provided by a lender, usually a bank, credit union, or non-bank lender, and is repaid in instalments that include both the borrowed amount (called the principal) and interest charges.

Key terms you’ll come across include the principal, which is the original amount borrowed, and interest, which is the cost charged by the lender for lending that money. The borrower is responsible for meeting the agreed repayment schedule, while the lender retains the right to repossess the property if the loan is not repaid.

How Home Loan Repayments Work

Repayment Types

Most home loans fall into one of two repayment structures: principal and interest, or interest-only. With principal and interest loans, each repayment reduces your outstanding debt and also covers the interest that accrues over time. This is the standard arrangement for most people buying a home to live in.

Interest-only loans, on the other hand, require you to pay only the interest for an initial period, usually between one and five years. These are more commonly used by investors looking to minimise upfront costs, though they tend to result in higher total interest costs in the long term.

Repayment Frequency and Terms

Lenders typically offer weekly, fortnightly, or monthly repayment options. While the frequency doesn’t change the interest rate itself, making more frequent repayments can slightly reduce your total interest over the life of the loan.

The length of your loan term plays a major role in your financial commitment. A 30-year loan term means lower monthly repayments, but you’ll pay more in interest over time. A 20-year term results in higher repayments but allows you to own your property sooner and pay less interest overall.

Understanding Interest on Home Loans

Fixed vs Variable Interest Rates

Interest rates can be either fixed or variable. A fixed rate means your interest stays the same for a defined period, offering predictable repayments and protection from rate rises. This is helpful for budgeting, especially during the early years of a loan.

Variable interest rates fluctuate in response to market conditions and Reserve Bank decisions. While this means your repayments can go up or down, variable loans often come with more flexible features like offset accounts and extra repayment options.

Some borrowers choose to split their loan between fixed and variable, combining the security of a fixed rate with the flexibility of a variable component.

Comparison Rates and True Costs

To help borrowers understand the actual cost of a loan, lenders provide a comparison rate, a figure that combines the interest rate with most upfront and ongoing fees. It gives a more realistic view of what you’ll pay over time. However, it’s still important to read the fine print and look out for additional costs such as discharge fees, redraw limits, and early repayment penalties.

Types of Home Loans in Australia

Home loans come in several forms, each designed for different types of buyers and needs. Here’s a simple comparison to help clarify the differences:

Loan Type	Description	Who It’s Best For
Owner-Occupier Loan	Designed for people buying a home to live in	First-home buyers, families, upgraders
Investor Loan	Structured for investment properties, often with interest-only repayments	Property investors
Basic Home Loan	Lower rates with minimal features	Budget-conscious borrowers
Package Loan	Combines home loan with other products (e.g. offset, credit card) for a fee	Borrowers wanting flexibility and extra features
Introductory Rate Loan	Offers a discounted interest rate for the first 1-2 years	Short-term savings seekers
Split Loan	Divides the loan into fixed and variable portions	Those wanting a balance between stability and flexibility

Choosing the right type of loan depends on your financial goals, how long you plan to stay in the property, and whether you prioritise flexibility, stability, or low costs.

The Role of Lenders and the Approval Process

What Lenders Look For

When you apply for a home loan, lenders assess your ability to repay it. This includes looking at your income, regular expenses, credit history, employment stability, and existing debts. One of the most important factors is your deposit size; a 20% deposit is ideal, as it allows you to avoid Lenders Mortgage Insurance (LMI), but many lenders accept deposits as low as 5%.

They also calculate your Loan-to-Value Ratio (LVR), which compares the loan amount to the property’s value. A higher LVR may result in stricter lending conditions or additional costs.

Pre-Approval and Final Approval

Pre-approval, also known as conditional approval, gives you a clear idea of how much a lender is willing to let you borrow. While it’s not a guarantee, it can be a useful guide when house hunting. Final approval happens once you’ve found a property and the lender has completed their due diligence, including a formal property valuation and verification of your financial documents.

If you’re ready to explore your borrowing power or want expert support with the pre-approval process, our mortgage broker, Todd Davies, can guide you through the next steps.

Common Questions About Home Loans

What is a typical deposit for a home loan?

Most buyers aim for a deposit of at least 20% of the property’s value. While some lenders allow smaller deposits, anything under 20% usually triggers LMI, which protects the lender in case of default.

Can I get a home loan with a low credit score?

It’s possible, but a low credit score may mean fewer options or higher interest rates. Improving your credit history before applying can increase your chances of approval and better loan terms.

What is Lenders Mortgage Insurance (LMI)?

LMI is a one-off premium that you might have to pay if your deposit is less than 20%. It protects the lender, not the borrower, and is either paid upfront or added to the total loan amount.

Do I need a mortgage broker?

While not essential, mortgage brokers can help you compare loans across multiple lenders, explain complex terms, and assist with paperwork, especially helpful if it’s your first time applying for finance.

What to Know Before You Apply

Understanding how home loans work is an important step toward making confident, informed decisions during the property buying process. Take time to research and compare loan features, not just interest rates. Look at how repayments fit into your lifestyle, consider the potential for future rate changes, and don’t hesitate to seek professional advice.

The right home loan can save you thousands over the life of the loan, and getting it right from the start will set you up for a more stable financial future.

This article contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information.