Understanding home loan interest rates
Interest rates play a significant role when you take out a loan as they affect your repayment amount and the total of your mortgage. It’s important to understand what it is and how it affects your home loan overall.
Interest rates play a significant role when you take out a loan as they affect your repayment amount and the total of your mortgage. It’s important to understand what it is and how it affects your home loan overall.
What are mortgage interest rates?
Essentially, the interest rate on your mortgage is the cost of borrowing money from the lender. Interest rates vary depending on RBA cash rates, inflation rates, loan amounts, borrowers' credit scores, and other factors determined by the lender.
When you take out a loan, your repayments will consist of two parts: principal and interest. The money you borrow from the lender is called the principal, while the interest rate is the annual cost of the loan.
Your interest rates dictate how much interest you pay back on your loan. The higher the interest rate, the higher the interest costs and vice versa. This is why finding a mortgage with low rates is a priority of many borrowers when they want to save costs.
How is interest calculated on a home loan?
Interest rates are usually expressed in percentage terms called the Annual Percentage Rate (APR). Your lender calculates the interest by multiplying the amount of your loan by the interest rate. They then divide that amount by 365 days or 366 days in a leap year as the APR is calculated yearly.
To calculate the interest cost per day, you can use the following formula:
(Principal Amount x Interest Rate) ÷ Span of Time = Interest Cost per day
As an example, let’s say you have a $500,000 home loan with a 6% interest rate and you want to find out your monthly interest payments. You can do so by following the formula below:
($500,000 x 0.06) ÷ 365 = $82.19
To see how much interest you pay in a month, simply change the span of time from 365 to 12. The calculation above only shows how much you’ll pay for an interest-only mortgage. If you want a better idea of how much interest you’ll pay on a loan, use an online home loan calculator. This online tool can help you understand how interest rates, repayments, and type of loan can affect the overall cost of your mortgage.
What affects interest rates and interest payments?
Interest rates change based on the cash rate and the lender’s cost of funding. Meanwhile, interest repayments are based on the specifics of your loan. Factors that affect a mortgage’s interest rate and repayment amounts include:
-
Loan purpose – The interest rate may vary if you’re buying an owner-occupied or investment property. Investment loans often have higher interest rates than owner-occupied loans.
-
Interest rate type – Home loans come with a fixed interest rate or a variable interest rate. If you have a fixed rate loan, your interest rate is locked in for a period of time. By contrast, a variable rate changes over time. Some people split their home loans to include both variable and fixed interest components.
-
Loan repayment type – With a Principal and Interest loan, you will repay some principal each month as well as the interest. An Interest-only loan is where, for a set period, you’re only paying the interest while the principal amount is unchanged.
-
Credit score and finances – Lenders look at a borrower’s credit score and finances to determine their risk of defaulting. If a borrower is considered low-risk, they have a better chance of getting lower interest rates compared to high-risk borrowers.
-
Principal amount – The more you borrow, the more you have to pay back in interest. If you can put a downpayment of 20% or more, this can help reduce the total interest costs.
How can you reduce the interest paid on a home loan?
A simple way to lower your mortgage’s overall interest cost is by making extra payments. More frequent repayments—weekly or fortnightly instead of monthly— can also help reduce the interest paid over the life of the loan.
You can reduce the interest paid through an offset sub-account, as well. At loans.com.au, we offer offset sub-accounts as a feature on your home loan. You can deposit your salary and/or rental income in this account to offset your remaining loan balance. You’re free to redraw the funds from the loan anytime.
Refinancing your mortgage is another way to reduce the interest paid on a home loan. If rates have decreased significantly since you got your current loan, refinancing could help lower costs significantly. This option involves leaving your current home loan and applying for a new one with lower rates. However, it can be a complicated and costly process.
Save on interest by getting a low rate home loan
The best way to save on total interest costs is by finding a home loan with competitive rates and useful features like redraw facilities, offset sub-set accounts, and free early payments. Also getting a home loan with minimal ongoing fees can help you save hundreds (if not thousands) over the course of your loan.
Find the ideal home loan with loans.com.au! Get in touch with our friendly lending specialist to learn more about our range of mortgage options. Call 13 10 90 or apply online today!
Find out in under 2 minutes if you qualify for one of our low rate home loans.
About the article
As Australia's leading online lender, loans.com.au has been helping people into their dream homes and cars for more than 10 years. Our content is written and reviewed by experienced financial experts. The information we provide is general in nature and does not take into account your personal objectives or needs. If you'd like to chat to one of our lending specialists about a home or car loan, contact us on Live Chat or by calling 13 10 90.
