Preparing for a Mortgage in Australia: What to Know First

A home loan is the largest long-term financial commitment most people ever make. In Australia, there are many different types of loan with very different features. This article explains the basic concepts so you understand what you are choosing — it is not personal financial advice. To make a decision that suits your circumstances, speak to a licensed mortgage broker or credit adviser.

Principal & Interest vs Interest Only

These are the two basic repayment structures:

Principal & Interest (P&I): Each month you pay off both the principal and the interest. The debt gradually reduces over time, and by the end of the loan term you own the property outright. This is the most common type for owner-occupiers.

Interest Only (IO): For a set period, you pay only the interest — the principal balance doesn’t change. The monthly repayment is lower during the IO period, but once it ends, the P&I repayments will be significantly higher because you have to pay off all the principal over a shorter remaining term.

Variable vs fixed vs split rates

Variable rate: The interest rate can change at the lender’s discretion (usually in line with market rates and the policy of the Reserve Bank of Australia — RBA). Pros: more flexible, you can usually make extra repayments at any time without penalty, and you may have an offset account. Cons: you can’t predict next month’s repayment.

Fixed rate: The interest rate is locked in at a set level for a certain period (usually 1–5 years). Pros: you know your monthly repayment exactly and aren’t affected if market rates rise. Cons: if you want to make extra repayments or exit before the term ends, there is usually a break cost — which can be substantial.

Split loan: Part of the loan is at a fixed rate and the rest is at a variable rate. This lets you balance certainty against flexibility.

LVR and Lender’s Mortgage Insurance (LMI)

LVR (Loan to Value Ratio) is the ratio of the loan to the value of the property. For example: buying a home for $800,000 and borrowing $640,000 gives an LVR of 80%.

When the LVR exceeds a certain threshold, the lender requires you to take out Lender’s Mortgage Insurance (LMI). LMI protects the lender (not you) in the event that you default and the property value is not enough to recover the loan.

LMI can be a substantial cost — it is often added to the loan, so you also end up paying interest on the LMI.

What does your borrowing capacity depend on?

Lenders assess your ability to repay based on a number of factors:

Income: Including salary, business income, rental income, and so on. Some income sources are counted at a lower rate (for example overtime or short-term contract income).
Living expenses: Lenders use both the figures you declare and industry benchmarks.
Existing debts: Credit cards (including unused limits), car loans, HECS/HELP, and so on.
Number of dependants: Children and other dependants reduce your borrowing capacity.
Serviceability buffer: Lenders add a buffer on top of the current interest rate to test whether you could still repay if rates rose. This is a mandatory requirement set by the regulator, APRA.

Use the borrowing calculator on moneysmart.gov.au for a rough estimate. But only a conversation with a broker or lender will give you a precise figure.

Pre-approval and full approval

Pre-approval (conditional approval or approval in principle): The lender reviews your financial information and confirms they are willing to lend up to a certain amount, subject to conditions. This is not a firm commitment — the lender still needs to assess the specific property.

Pre-approval is usually valid for a few months and can be renewed. It is very useful because:

It tells you your realistic price range
It boosts your credibility when negotiating (sellers know you’re serious)
It is essential if you intend to bid at auction

Full approval (unconditional approval): The lender has assessed both your finances and the specific property’s value, and has committed to lend. This happens after you have chosen a home and the lender has valued the property.

Mortgage broker or go directly to a lender?

A mortgage broker is an intermediary who works with many lenders and lending institutions. They earn a commission from the lender once a loan is successfully arranged.

The advantages of a broker:

Access to many loan products from many lenders at once
They may find better terms for your specific situation (especially if your circumstances are complex, such as being self-employed, a new permanent resident, or having variable income)
They handle most of the paperwork for you

If you choose a broker, ask clearly how many lenders they are comparing and whether their commission influences their advice.

Documents you usually need to prepare

When you apply for a loan, the lender or broker will usually ask for:

Proof of income: Recent payslips, tax returns for the last 1–2 years, and your Notice of Assessment from the ATO
Proof of assets: Bank statements for the last 3–6 months, evidence of savings
List of existing debts: Credit card statements, other loan agreements
Identification: Passport, driver’s licence, visa (if you are a permanent resident)

If you are self-employed, the requirements are usually stricter — typically two years of business and personal tax returns, along with financial statements.

Important note: This article describes general concepts. Interest rates, LMI levels, LVR thresholds and actual borrowing capacity change with the market and each lender’s policy. Use moneysmart.gov.au for a rough calculation and consult a licensed mortgage broker or credit adviser before making a decision.