How do home loans work?

Applying for a home loan, especially if you're a first-home buyer, can feel very confusing.

Today, Australian home buyers have more mortgage choices than ever. The home loan market is incredibly competitive, and this is why it's important for you to research all your home loan options.

Knowing which options are available will help you make an informed decision when choosing a home loan, based on your budget, personal circumstances and future property purchases.

In this  article, you'll find out how home loans work in the Australian property market and specific terms you'll need to know when understanding home loans.

According to the Australian Bureau of Statistics’ (ABS) June Quarter 2025 release, there were $16.2 billion worth of new home loan commitments for first home-buyers [1]. Meanwhile, the average loan size for owner-occupied properties in Australia is $678,000. [1]

In the last five years, lenders’ interest rates (for new loans) decreased from 3.5% in July 2019 to 2.4% in April 2022. Interest rates grew steadily and peaked in January 2024 at 6.3%, remaining at this level until November 2024. As of the time of writing, the interest rate has continued to decrease since then. [2]

In recent years, an increasing number of households with mortgage debt have spent more than 30% of their disposable income on housing. In 2024-25, nearly 60% (57.7%) of households headed by someone under the age of 35 were spending more than 30% of their income on housing. [3]

A mortgage broker is a financial intermediary who researches, provides options and matches borrowers with a lender, typically a bank or other financial institution. Once you’ve applied for a loan, your mortgage broker can manage the process through to settlement.

A mortgage broker should:

• Understand your needs and goals
• Work out what you can afford to borrow 
• Find options to suit your financial situation 
• Explain how each loan works and what it costs 
• Have a licence to give you credit (loan) advice

A home loan consists of two components: the principal and the interest. The principal is the total amount you're borrowing, and the interest is the fee charged by the lender for borrowing money.

Interest rates are calculated as a percentage of the loan amount. Once you've been approved for a home loan, you normally start making loan repayments, choosing to pay back both the principal and the interest or interest only payments.

Your interest repayments are influenced by:

• The loan amount - The more money you borrow, and the longer the term of the loan, the more interest you'll repay over the term of the loan.
• Regular repayments - The more frequently you're able to make repayments, the less interest you'll pay on your home loan over time. If you're in a position to make extra repayments, you can reduce your total interest payments even further.
• The official cash rate - Interest rates on home loans are based on the official cash rate set by the Reserve Bank of Australia (RBA). Typically, an increase in the cash rate may lead to a hike in lending interest rates, while a drop can prompt lenders to lower their interest rates.
• Linking to an offset account - Some home loans come with an offset account, which allows you to offset the total principal against the funds in the offset account.

Your outstanding balance - This is the amount you still owe on your loan. Interest is calculated on this balance, so as you make repayments and the balance decreases, the dollar amount of interest you are charged also becomes smaller.

Typically, home loans are between 10 - 30 years, depending on the loan type and agreed-upon monthly payments.

The three most common home loan types in Australia are fixed-rate, variable-rate and split.

There may also be several fees involved in the process. These might include application fees, annual fees, legal fees, settlement fees, exit fees, account-keeping fees and break fees (for fixed-interest loans).

With a fixed-rate loan, repayments and interest rates are locked in for a specified term. This means you’ll always know exactly how much you need to pay, on either a fortnightly or a monthly basis. 

Once you reach the end of your fixed-term loan, you can either change to a variable interest rate or negotiate another fixed-term rate. 

Fixed-rate loans can be a good choice if you believe interest rates are likely to rise, but you could also end up paying more if rates drop. A potential disadvantage of a fixed-rate loan is that you may not be able to make additional repayments. Some lenders allow you to make some extra repayments, but they are capped at a maximum amount per year.

It may also cost more to switch loans later (especially if you have to pay a break fee).

A variable rate home loan involves paying an interest rate that varies depending on changes to the RBA's official cash rate, changes made by the lender or fluctuations in market interest rates.

Variable rates are a popular option in Australia because of their flexibility. They usually allow you to make additional repayments to pay off your debt and may include the option to redraw those additional funds if you need them in the future.

A split home loan is a combination of the two loan types above. You'll decide how to split the loan and pay part of your loan at a fixed rate and the rest at a variable rate.

This means you'll benefit if rates go lower, but still have some protection from rising rates. Because you can set the balance of the fixed and variable components to suit yourself and your financial situation, there's a bit more certainty with payments and a level of flexibility.

A bridging loan allows you to bridge the gap and pay for a new home before you've received the money from the sale of your existing one. Generally, the lender secures both homes until the existing home sale has gone through.

The main benefit of getting a bridging loan is convenience. But there are downsides, too.

Bridging finance is an additional loan on top of your home loan and may cost more. This may be due to:

• Interest on the bridging loan is charged monthly, so the longer it takes to find a buyer for your old home, the more interest you'll pay.
• Bridging finance might result in two property valuations (existing and new home) and therefore two valuation fees and any additional fees for the extra loan.
• If your existing home doesn't sell within the term of the bridging loan, you could end up paying a large amount of interest or even have the bank step in to sell your home. 
• If the house you're buying requires a substantial home loan and you sell your existing home for much less than you thought, you could be left with a larger-than-expected home loan amount and extra financial strain.

Three ways you can avoid needing a bridging loan are: 

1. Wait until the money comes through on your old house before purchasing a new one.
2. Put a ‘subject to sale' clause in the contract for the new house 
3. Negotiate a longer settlement period for the new home, which allows you more time to sell the one you're still living in.

If you do consider a bridging loan, consult a financial professional first to ensure it's the right choice for you.

If you're building a new home, one option worth considering is a construction loan. A construction loan is structured so you only draw out necessary funds (called progress payments) for the builder at key stages of the construction process. While the building is in progress, you only pay interest on the money that has been used.

This is a loan that allows you to draw money from the principal. Your borrowing amount should correspond with the main stages of building.

Dwelling construction is divided into five stages:

1. Land purchase
2. The pad (floor)
3. The roof (normally including frames)
4. Lock-up
5. Final work

As each phase of the build is completed, you can access the next portion of the loan to finance the next phase.

Here are some helpful terms to keep in mind when researching how home loans work.

The comparison rate includes the interest rate plus most of the fees that must be paid over the term of the loan. Keep in mind the advertised interest rate (also known as the headline rate) on a home loan is just the interest alone.

By law, Australian lenders must display a comparison rate to help you understand the true cost of a loan. It's a rate that includes interest and most fees like application, establishment, and ongoing account fees.

Because it is always calculated on a standard loan of $150,000 over 25 years, it allows you to make a fair comparison between different loans and lenders.

How much your home is worth, taking away how much you still owe on your home loan. The further along you are in paying off your loan, the more you own of your property than before.

A guarantor loan typically requires a small deposit, although some may require no deposit.

And to be eligible for this type of loan, you will need to have someone who can be your guarantor. Keep in mind that the guarantor must be a homeowner.

A guarantor is a person who helps you secure a home loan by taking on responsibility for a guaranteed part of your loan if you’re unable to make the payments. This is usually a close relative such as a parent, grandparent or sibling.

The equity in their home will help secure part of your first home loan.

With an interest-only loan, you only pay interest for an initial period (typically 1-5 years).

Although you’ll have lower repayments at the beginning, you won’t be paying off the principal you borrowed, and your interest-only repayments will go up after the interest-only period is finished.

Lenders use introductory loans to offer the lowest available interest rates to attract borrowers.

These rates last for around a year, when they revert to standard variable home loan rates.

The more payments you can make at these introductory rates, the more quickly you'll reduce the principal.

Investment property loans are used to invest in properties such as land, houses, and apartments.

This type of loan is based on the built-up equity in your property and allows you to access funds when needed.

It offers a flexible way to get access to a line of credit, but it can also reduce the equity in your home and usually involves higher interest rates than a standard home loan.

A line of credit loan can potentially cost you more than expected if you're not making regular repayments on the principal.

Lender's Mortgage Insurance protects the lender if you default on your home loan.

Generally, if you borrow more than 80% of the property's purchase price, the lender will require you to pay for a Lender's Mortgage Insurance policy, since their risk is increased.

The LVR shows how big the loan is as a percentage compared to the lender-assessed value of the home. For example you are taking out a $680,000 loan on a home that the bank valued at $860,000 so your LVR would be 79%.

This loan requires less financial documentation than a standard home loan and is typically a good option for buyers who are self-employed. 

While less paperwork is required to prove income, assets and liabilities, you can also expect to pay higher interest rates and fees.

This is your ability to pay your home loan repayments based on criteria such as your income and expenses. Keep in mind that every bank has different criteria and a different way of calculating serviceability.

Negative gearing happens when the cost of owning a rental property is higher than the rental income it generates each year. In this case, you may be able to claim a tax deduction for rental expenses against your other income, such as salary, wages or business income.

It’s advisable to get independent financial advice before you negatively gear your property.

Potential home buyers who have a poor credit rating or an unconventional financial situation pose a greater risk to the lender.

In a non-conforming loan, the lender will want to see some evidence of your ability to repay the loan.

While the interest rate is based on the state of the applicant's credit history, a larger deposit is usually required to secure the loan.

This is a separate account where you keep money to ‘offset' your loan amount. The balance in your offset account works daily against your principal. 

For example, if your total home loan is $380,000 and you've got $30,000 in your offset account, you're only charged interest on $350,000 ($380,000 - $30,000).

The property settlement process is the transfer of ownership from the seller to the buyer.

The property settlement period begins when the contract of sale is signed and concludes on the settlement day when the change of ownership will take place.

With advice from your conveyancer or solicitor, you can take steps to prepare for settlement day, and then look at home insurance before settlement.

When you make extra repayments on your home loan above what's required, these are considered advanced payments. Depending on the type of loan you have and it’s conditions, you may be able to redraw on these advance payments to access these funds.

When you use the redraw facility, the balance of the loan will increase and it will impact the interest calculations on your loan.

Refinancing is when you get a new home loan to replace the current loan.

You might do this to take advantage of better interest rates or to access more advantageous loan features with another lender.

Reverse mortgages make it possible for homeowners to borrow money using part of their home's built-up equity.

However, reverse mortgages can be complicated, so you'll need to get independent financial or legal advice before you go ahead. You will need to pay the bank back the amount you draw on plus the interest.

Also known as Transfer duty, stamp duty is a state or territory tax on certain purchases, including the transfer of a dutiable property.