Home loans and interest rates can seem complex when first approaching a bank.

In this section we cover the basics of how home loans work, what types of loans you can get, what interest rates are and some ways to work out how much you can borrow.

Remember, it is always recommended to do your own research about how much you can afford to repay before talking to a bank or broker. If you're not sure, try talking to a family member or friend who's done this before.

What is a home loan?

When the bank lends you money to buy a property, you have received a home loan.

A home loan is different from a mortgage, though the words are commonly used interchangeably.

A home loan is a type of loan specifically designed to help people purchase a home or property. It is a long-term loan provided by a financial institution, such as a bank or a mortgage lender, and is usually guaranteed by the property itself.

A mortgage refers to the security your lender puts in place on your home loan until you repay it. The mortgage protects the bank if you fall behind on your repayments and enables the bank to repossess the property if you fail to repay the loan on time. The lender then has the right to sell the home to recover the outstanding balance of the loan.

Your lender will charge interest on the amount you have not paid back, alongside additional fees related to being a customer. This means that the total amount you will repay for your loan will be more than the amount you initially borrowed.

What is the difference between a home loan and a construction loan?

Construction loans are loans designed specifically to fund building projects, like building a new a home or making renovations on an existing property.

When taking out a regular home loan, the funds are paid in one lump sum and the you pay the loan back accordingly, with interest calculated on the outstanding sum. 

A construction loan allows the borrower to progressively withdraw funds from the loan account (up to an approved limit) when payments are due from the builder. These payments are known as ‘drawdowns’. 

You only pay interest on the money that has been drawn on, not on the full amount of the approved limit. Lenders frequently impose other conditions on the borrower and the building project before they approve a construction loan.

See more about obtaining a construction loan in our Building your Own Home section.

What is interest?

Interest is the fee you pay for borrowing money.

You will pay interest on your home loan. Your home loan repayments will consist of the 'principal’ (the loan amount) and the 'interest' (the cost of borrowing calculated as a percentage of the loan amount).

As you pay back your principal loan amount over time, you will only pay interest on the outstanding (what's left) loan balance.

You will also be charged fees, such as an establishment fee and possibly monthly ongoing fees. How much interest you pay is determined by the interest rate offered by your lender and can change over time. To compare the costs of different loans, look for the 'comparison rate,' which takes these differences into account.

There are two types of interest rates:

• Fixed - meaning the interest rate stays the same for a predefined period of time of the loan, typically in Australia, this is between 1 to 5 years.
• Variable - meaning the interest rate will change over the term of the loan based on certain economic measures

If the variable rates increase, your repayments will also increase. Fixed rate loans have the advantage of knowing what your repayments will be, however, if you have a fixed rate loan and variable interest rates fall, then your fixed rate loan will be more expensive than a variable rate loan for the same amount. On the other hand, if variable interest rates rise, it will be cheaper. Once a fixed rate period ends, the variable rate will apply to your loan unless you decide to fix the rate for another period.

Some lenders allow you to make 'interest only' repayments. Here the month-to-month repayments appear lower for a period of time, however as you are paying only the interest accruing on your loan, and not directly contributing to your principal loan, it will take longer to pay off your loan completely.

Lenders typically display their interest rates on their websites, often included in a mortgage repayment tool too. You can research these rates online, and use comparison sites. For example, you can find the current average interest rate via the Moneysmart.com website.

How much can I borrow?

Each lender will assess how much it will lend to you based on your income, your expenses and liabilities, your credit history and the interest rate of the loan product you choose. See more on these criteria in our Applying for a Home Loan section.

Lenders will conduct 'Loan Serviceability Tests' to work out if you are eligible for a loan. This test considers your income, debts and credit history, expenses and savings, among other things.

Once your eligibility is determined, you will understand the amount you are able to borrow from the lender. The greater your principal loan, the higher your monthly repayments will be.

Lenders usually require you to have saved around 20% of the value of the home to use as a deposit. Some lenders will allow you to have a smaller deposit and in turn, will require you to buy 'lenders mortgage insurance' (LMI). Learn more about LMI in Common Costs.

You can use online mortgage calculators to workout what is an affordable amount for you to borrow. For example, Moneysmart.com has a calculator tool that you can use.

When do I have to repay my loan?

As determined by your home loan contract, you will be required to repay your loan over several years, according to your 'loan term'. 

A common loan term is 25 to 30 years.

Typically, the longer the loan term, the lower your repayments will be each month. However, you will pay more in interest over the life of the loan. Read more in our Home Loan Repayments section.

Who can help me choose a home loan?

It is important that you work out your own budget and decide how much you can afford based on your needs and priorities.

A financial planner or advisor can help you to choose a home loan that may suit your needs best. Financial planners or advisors typically charge a fee for their services.

A Mortgage Broker can help to find the best possible loan for your financial situation and requirements; however, they are typically paid by commission and so while they do not charge you for their services, they are not independent.

Talking to an accountant or Financial Counsellor may be an independent way to get an understanding of what you can borrow. Financial Counsellors are available at no cost.

See more information on professional supports in our Connect section.