Understanding Home Loans

We’ve broken down some of the more confusing words into plain English, so you know exactly what you’re dealing with.

Remember, any advice provided on this website is of a general nature only and does not take into account your personal needs, objectives and financial circumstances. You should consider whether it is appropriate for your situation.

Home loan language can often feel confusing, but we’re here to help remove some of the mystery.

1. Rates

Every home loan comes with an interest rate. That's how much you pay the bank for using its money to buy something. It's calculated as a percentage of the outstanding loan amount, usually on an annual basis.

The rate you pay will depend on a few different factors. For example, your Loan to Value Ratio, the rate period you agree to, and even being a new customer can all change the rate you'll pay.

Let's say your rate is 6% on a 30-year loan. If you borrow $550,000, you'll pay 6% of that amount in interest on top of the actual amount that gets taken off your loan, or $3,298 per month in total. If you paid that same rate for 30 years, you would pay a total of $637,110 in interest.

There's a lot of calculators out there that can give you an idea of what your repayments might look like (checkout Up's here) and how much it could change if interest rates go up or down.

a. Comparison rates

When you're doing your own research into home loans, you'll probably see one interest rate listed and then a 'comparison rate' next to it. A comparison rate uses the advertised rate but bundles in all the extras you'll be paying, which includes fees and charges. It's designed to give you a more accurate idea of the cost of the loan, so you can easily compare it to rates from other banks.

There can be a lot of hassling and haggling that goes on in the rate world, but with Up Home, existing Upsiders and new ones all get the same variable rate, and it’s always the best rate we have to offer.

b. 'Fixed' vs 'Variable' rates

Interest rates change, like the rest of the economy. They respond to supply and demand, geopolitical factors, and even unexpected events, like global pandemics.

That means there's an element of risk, so the bank gives you the option of setting a 'fixed' rate for a period of time, or having a rate that varies as the market changes.

A fixed rate home loan offers a dependable, predictable payment. You won't be able to fix it forever, but you may have the option to keep your interest rate the same for 1-5 years, during which time your repayment will be exactly the same.

Some fixed-rate loans are also stricter about how you can pay them off, including whether you'll be able to contribute more funds when you have them. At the end of the fixed term, it will usually revert to a variable rate.

A variable rate home loan tends to be more flexible. The interest rate changes over time, which means your repayments can go up and down. One up side is that banks are usually more comfy with letting you pay a variable loan off faster; another is that if rates go down, you benefit.

The flip side of having lots of flexibility is that if something catastrophic happens in the market, you could find your repayment becomes less affordable, so you'll have to factor that in.

2. Principal & interest vs interest only

Your loan is made up of two elements: the principal and the interest.

The principal is how much you actually borrowed to buy your actual home. It doesn't include the extra amount you pay to the bank on top of that, which is the interest we mentioned earlier.

A principal and interest loan is one where you put money towards both the actual cost of your home and the interest you have to pay the bank. That means the money you owe on your principal is also reduced over time. If you continue to pay a principal and interest loan for the whole loan period, you will own your home outright at the end.

An interest-only loan is one where you don't pay any money towards the principal. You just pay interest to the bank in exchange for living in your home. The principal amount you owe stays the same for the lifetime of your loan, and at the end of the loan term, you'll still owe that money. If you sell, you'll use the sale price to pay out the loan and keep any leftovers.

Usually, people tend to use interest only loans for investing in property; principal and interest for homes they plan to live in.

3. Repayment frequency

When you get a mortgage, you agree to make regular loan payments to your bank, but most will let you choose the frequency - say, monthly or fortnightly.

This can really help with budgeting. If you get paid weekly or fortnightly, you might opt to pay at the same interval. If your pay is irregular or unpredictable, you might make deposits into your home Saver and make one bigger repayment each month. You may also have the option to make extra repayments during flush times, which will reduce the amount you owe and shorten the life of your loan.

Pro tip: if you split your monthly payment into two, paying fortnightly rather than monthly can add a sneaky extra payment or two into a standard calendar year, and shorten the length of your loan.

4. Offset accounts

Having a home loan can be a bit of a juggle. You need to prioritise your mortgage repayments, but you also need to eat, keep the lights on, and treat yourself from time to time. An offset account can reduce the cost of your repayments without taking away your money forever.

The way it works is: you have a home loan account and an offset account. The offset account is just like a savings account, but it's linked to your loan. The money in the account counts towards (or is 'offset' against) the total amount you owe. For example, if you have a $320,000 loan but you also have $10,000 in your offset account, the interest you'll pay is calculated on $320,000 - $10,000 = $310,000. This adjusted balance, known as the Offset Loan Balance, is the one used to calculate your interest.

Dropping your pay into the offset account can be a great habit if you want to pay less interest (you do). And because it's a savings account, you'll still have access to the money in there when you need it. With Up, you can create up to 50 Savers, all of which become free 100% offsets on both fixed and variable loans.

Plus, your deposits are protected by the government's Financial Claims Scheme (FCS) for up to $250,000. This is peace of mind you won’t get with non-bank lenders.

5. Redraw facilities

As we've mentioned, you might have the option to make extra payments on your home loan, when you can afford to. That's great - it brings down the length of your loan.

But what if you get stuck? What if you make an extra repayment and then an unexpected expense rears its head, and the money is gone?

A redraw facility allows you to withdraw that extra money, if you need it. Any amount you've paid over and above your regular repayment commitments can be taken out and used for other things. Some banks, like Up, don't charge a fee to do this, though be mindful that those savings you made earlier will be lost. 

6. The difference between redraw and offset

We can hear you asking - isn't that just an offset account? It's true that there are similarities, but they're not the same.

An offset account is yours. It's money you never actually pay towards your home loan. It stays in its separate account and you use it to buy what you need, like a regular transaction account. You can have your wages paid directly into it, unlike a mortgage account. As long as there's money in the account, you'll pay less interest than you would if it was empty.

A redraw facility isn't a bank account, it's part of your loan's features. You shoot extra money across to your mortgage account and reduce the overall balance, which is why you pay less interest. But you can't just spend that money without first transferring it back to your transaction account. It's hanging out with your regular mortgage payments until further notice.

Money in an offset is legally yours; redraw is money you've already paid the bank, but the bank says it's OK to borrow it again. So they don't HAVE to let you have that money back, and if something goes badly wrong they may not.