Pay Your Way The lowdown on mortgages.

There’s no right or wrong route to financing a home loan, but it’s important to understand how a mortgage works before you take one on.

Not all mortgages are created equal. Today there are a few different financing options available to homeowners. Here are some of the most common mortgage types:

Variable-rate mortgage

“If you have a variable-rate home loan, the interest rate on your mortgage will change from time to time throughout the life of your loan,” says Dimitra Dinos, general manager of home loans for Commonwealth Bank. “When the official interest rate goes up or down, so too will your regular mortgage repayments.”

Variable-rate home loans are popular with borrowers seeking greater flexibility. “Generally speaking, variable-rate home loans allow borrowers to make extra payments – above their minimum repayments – if they choose,” she says. Borrowers who make additional mortgage repayments can pay off their loan sooner and pay less in interest over the life of their loan.

As an example, a borrower who makes an additional payment of $100 per month on their $500,000, 30-year variable rate loan with an interest rate of 4% p.a., could potentially shave more than two years off their home-loan term and save themselves in excess of $30,000 in interest over the life of their loan.

Fixed-rate mortgage

With a fixed-rate home loan, you lock in an interest rate for a set period of time, usually between one and five years. Once that period expires, you’ll have the option to revert to a variable-rate home loan or enter into another fixed-term contract.

“The main benefit of a fixed-rate home loan is cash-flow certainty,” says Dinos. “With a fixed-rate home loan you protect yourself against any rate changes and therefore know exactly how much your repayments will be over the fixed-term period.”

While fixed-rate home loans offer cash-flow certainty, they can also restrict your flexibility. With fixed-rate home loans borrowers are usually limited in the amount that they can over-pay their mortgage. If you fix your loan but decide you want to pay it out sooner, you could potentially incur an early repayment fee. You will also miss out on the benefits of any interest-rate reductions that occur during the fixed-term period.

Split mortgages

A split home loan divides the loan into parts, meaning you nominate a portion of the loan to have a fixed interest rate and the remainder to have a variable interest rate. Split home loans are popular with borrowers who are looking for the flexibility of a variable-rate home loan and the repayment certainty that comes with having a fixed-rate mortgage.

“Everyone’s situation is different so we encourage borrowers to research the different loan options thoroughly and always speak to their lending specialist before signing on the dotted line,” she adds.

“Everyone’s situation is different so we encourage borrowers to research thoroughly.” Dimitra Dinos, gerneral manager of home loans, Commonwealth Bank