First home buyers
What Is a Mortgage? A First Home Buyer's Plain Guide
What is a mortgage? Learn how a mortgage works, principal and interest, fixed and variable rates, offset, redraw and LMI for first home buyers in Australia.
A mortgage is money you borrow from a lender to buy a property, which you pay back over time with interest charged on top. It is also called a home loan, and the two terms mean the same thing for most first home buyers. The amount you borrow is the principal, and as you make repayments you slowly pay that principal down while covering the interest the lender charges for lending it to you. If you have been asking what a mortgage is and how a mortgage works, this guide covers the parts that matter, in plain English, so the words on a lender’s website stop feeling like a foreign language.
This is general information only. What suits you will depend on your circumstances and each lender’s criteria.
If you are starting your buying journey, the deposit, scheme and lender decisions come together on our first home buyers hub.
Understanding mortgage basics as a first home buyer comes down to a handful of ideas: the principal, the interest, the rate, the repayments, and the features that sit around the loan. Get those straight and the rest follows.
How does a mortgage work?
A mortgage works as a long-term agreement. You borrow a lump sum to buy the property, the lender holds the property as security until the loan is repaid, and you make regular repayments across an agreed term. Home loan terms are commonly 25 or 30 years, according to the Australian Securities and Investments Commission’s MoneySmart service.
Each repayment is usually split two ways. Part covers the interest, which is the cost of borrowing, and part chips away at the principal, which is the amount you borrowed. This is called a principal and interest loan. MoneySmart explains that with a principal and interest loan you make regular repayments on the amount borrowed, plus you pay interest, and you pay off the loan over an agreed period.
There is another structure called an interest-only loan. With an interest-only loan your repayments only cover the interest, so you are not paying off the principal you borrowed and your debt is not reduced for that period. First home buyers more often start on principal and interest, because it actually reduces what you owe, but the right structure depends on your circumstances and the lender’s criteria.
Fixed rate and variable rate
The interest rate is the single biggest lever on what your repayments look like, and it comes in two main flavours.
| Fixed rate | Variable rate | |
|---|---|---|
| What it does | Stays the same for a set period, for example five years, then moves to variable or is renegotiated. | Can go up or down as the lending market changes, for example when official cash rates change. |
| Main appeal | Certainty, because your repayments do not move during the fixed term. | Flexibility, because the loan may offer more room to make extra repayments. |
| The trade-off | Less room to get ahead during the fixed term. | Your repayments can rise or fall over time. |
Neither is universally better. A fixed rate may help you budget, while a variable rate may offer more room to make extra repayments. Which one fits depends on how you want to manage your money and what the lender offers. Our guide to interest rates for first home buyers covers where rates come from and how they move.
Reading the true cost: the comparison rate
When you shop around, the advertised interest rate is not the full story, because loans also carry fees. This is where the comparison rate comes in. A comparison rate is a single figure for the cost of the loan that includes the interest rate and most fees. It exists so you can line up two loans side by side and see which is genuinely cheaper once the fees are counted, rather than being drawn in by a low headline rate that hides heavier costs.
Offset accounts and redraw
Many home loans come with features that can help you manage the loan or pay it down faster. Two of the most common are worth knowing before you sign anything.
A mortgage offset account is a transaction account linked to your home loan, and the balance in the offset account reduces the amount of your loan that is charged interest. MoneySmart gives a clear example: with a 500,000 dollar loan and 20,000 dollars in an offset account, you are only charged interest on 480,000 dollars. Your savings still sit there for you to use, but while they do, they quietly reduce your interest.
A redraw facility works differently. Extra repayments you make go straight onto your loan, and you may be able to withdraw those extra repayments later if you need to, depending on your loan terms. It rewards getting ahead on repayments while keeping a door open to that money.
An offset account and a redraw facility can both help, but they are not the same thing. An offset is a separate transaction account linked to your loan that you can access whenever you need it, while a redraw lets you pull back extra repayments you have already made. Whether either suits you depends on how you manage your money and the lender’s terms.
Deposit, LMI and the costs around the loan
A mortgage rarely covers the whole purchase. You contribute a deposit, and the size of that deposit matters for more than just the amount you borrow. A common savings goal for a house deposit is 20 percent of the purchase price, plus enough to cover buying costs.
The 20 percent figure is not arbitrary. A 20 percent deposit will avoid you needing to pay lenders mortgage insurance, known as LMI, and deposits below 20 percent typically require it. LMI is an insurance premium that protects the lender, not you, if you cannot repay the loan. It is a real cost first home buyers often meet, so it is worth understanding early, and our guide to lenders mortgage insurance walks through who may need it.
There is also stamp duty to plan for. Stamp duty is a one-off state government property-transfer tax that you typically need to pay within 30 days of settlement, though first home buyers may qualify for exemptions or rebates. These costs sit alongside the mortgage itself and shape how much deposit you actually need.
The steps to getting a mortgage
Getting a mortgage follows a fairly consistent path. MoneySmart sets out the journey to buying a home in clear stages, and the financing runs through all of them.
The mortgage decisions cluster around the first three steps, where you size your deposit, test your borrowing capacity, and choose a loan. To put real numbers against what you might borrow, the borrowing power calculator is a useful starting point.
Try the borrowing power calculator
Open the calculator to run your own numbers.
Seeing what those numbers turn into each month is the next piece, which our guide to first home loan repayments walks through.
A mortgage broker can help here. A mortgage broker is a go-between who deals with banks or other lenders to arrange a home loan, and brokers must act in your best interests when suggesting a loan for you. Before meeting a broker you should make sure they hold a licence to give you credit advice, which you can check on the regulator’s professional registers. If the terms still feel dense, our first home buyer glossary defines them one by one.
Where Finance Lab fits in
A mortgage is a long relationship, not a one-off purchase, so getting the structure right at the start pays off for years. Matching the loan to your income, your deposit, and the features you will actually use is where general guides stop and personal advice begins. The team at Finance Lab can walk you through how the principal, the rate, the repayments, and the features come together for your circumstances, and which lender criteria you may need to meet.
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