Home Loan Basics
Most Australians sign a 25–30 year mortgage without fully understanding the key choices they're making. This guide covers the core decisions — repayment type, rate type, and loan structure — and what each choice actually costs you over the life of the loan.
Principal & Interest vs Interest Only
Every mortgage payment either reduces your debt (principal) or just pays the bank's charge for lending you money (interest). P&I loans do both simultaneously. Interest-only loans do only the latter.
Principal & Interest (P&I)
With P&I, each payment contains an interest component plus a principal reduction. In the early years, most of the payment is interest. As the balance falls, the interest portion shrinks and more of each payment reduces the debt. On a $600k loan at 6.5% over 30 years: first payment = ~$3,792 (of which ~$3,250 is interest, ~$542 is principal).
P&I is the standard choice for owner-occupiers. You build equity from day one, qualify for better rates, and your total interest bill falls as the balance reduces.
Interest Only (IO)
IO means you only pay the interest — the principal balance doesn't reduce. This lowers your required monthly payment but you never reduce the debt. After the IO period ends (typically 1–5 years), the loan reverts to P&I on the original principal over the remaining term — causing a significant payment jump.
IO loan repayment shock example: $700k loan, 30-year term, 5 years IO at 6.5%. IO payment: ~$3,792/month. After 5 years, reverts to P&I over remaining 25 years: ~$4,720/month — a $928/month jump. Plan for this before taking IO periods.
IO loans are used by investors who maximise deductible interest (the interest payment is deductible; principal reduction isn't) and want to maximise cash flow. They're rarely the right choice for owner-occupiers.
Fixed vs Variable Interest Rate
Variable Rate
Your rate moves with the RBA cash rate (with a margin set by your lender). Variable rates offer flexibility: you can make extra repayments without penalty, access offset accounts, redraw, and refinance without break costs. Variable rates are typically lower than fixed rates when the rate cycle is falling.
Fixed Rate
Your rate is locked for a period (typically 1–5 years) regardless of RBA movements. Fixed rates give certainty — your monthly payment won't change. The cost: you usually can't make large extra repayments (capped at $10k–$20k/year on most fixed products), and refinancing before the fixed term ends incurs break costs that can be tens of thousands of dollars.
Most Australians who fix regret it if rates fall. Most who stay variable regret it if rates rise. The honest answer: neither is reliably better. Your lender already has teams of economists pricing rate expectations into the fixed rate — you're not outsmarter them.
Practical guide: Fix if you need certainty for budgeting (new family, single income, tight margins). Stay variable if you want to use an offset account aggressively, make extra repayments, or may refinance or sell within 3 years.
Split Loans
A split loan divides your mortgage into a fixed portion and a variable portion. Common split: 60–70% fixed (payment certainty), 30–40% variable (offset account, extra repayments). This is a reasonable middle ground for most households — you get rate certainty on most of the debt while retaining flexibility on the rest.
The Real Cost: Comparison Rate
The advertised interest rate doesn't include fees. The comparison rate does — it's calculated on a $150,000 loan over 25 years including application fees, annual fees, and monthly fees. For a no-frills variable loan, the comparison rate is usually close to the headline rate. For products with high annual fees or application fees, it can be meaningfully higher.
Always compare using comparison rates when looking at loans with similar features. Be aware the comparison rate's $150k/25-year formula may not reflect your actual loan size — on larger loans, fixed fees matter proportionally less.
Offset vs Redraw
Both reduce the interest you pay, but they work differently:
- Offset account: A separate transaction account. Your balance reduces the loan balance on which interest is charged. Money remains fully accessible. Treated as your own savings, not extra repayments.
- Redraw facility: Extra repayments go into the loan account, reducing the balance. You can redraw them later, but with some restrictions (some lenders can freeze redraw, minimum amounts apply, and there may be fees). For future investment property purposes, money put into the loan via extra repayments permanently changes the loan balance — unlike offset.
For most Australians, offset is the better choice for its flexibility and tax preservation advantages. See the mortgage offset guide for a full comparison.
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