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How do interest rates affect my home loan?

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When you take out a home loan the money you borrow is called the principal, while the interest rate is the charge for borrowing the money, expressed as a percentage per year.

For instance, if you take out a $400,000 loan on a 6.5% interest rate over 25 years, you will pay more than $400,000 in interest. So it’s worth considering the interest rate of your home loan. If you want to know the amount that goes towards your interest verses principal, you can use our home loan repayment calculator to see the difference.

Interest rates go up and down depending on factors including the cash rate set by the Reserve Bank of Australia (RBA) and your lender's cost of funds.

When it comes to changes to the interest rate, most lenders consider the cash rate along with their cost of funds. 

How can borrowers manage changing interest rates?

There are several features and types of interest rates homeowners can choose from to help manage their home loan repayments with changing interest rates, including:

Fixed rate

This allows you to have a fixed interest rate on your loan for a certain period of time. This means your repayments will stay exactly the same whether the interest rate of your lender goes up or down.

The advantage of a fixed rate home loan is that you won’t get affected by increased rates, and you know exactly how much you need to pay each month.

Variable rate

This is where your interest rate can go up and down. A variable rate loan gives you options not available to people with fixed rate loans. These include the ability to make extra repayments or add a lump sum to your home loan. However, you are exposed to the risk of increasing interest rates.

Split loans

You have the features of a variable rate and a fixed rate when you split your home loan. Meaning, one portion of your loan is fixed while the other is variable.

Knowing the advantages and disadvantages of the types of home loans is essential when comparing interest rates among various lenders.

Apart from the mortgage types, you should also consider the other features available such as making extra repayments, an offset sub-account, or even an interest-only option which may help achieve your financial goals.

4 ways to cope with rising interest rates

1.  Take a look at your long-term goals

You may be able to change your type of loan, but it shouldn't be a quick decision.

Consider factors that will affect your finances in the long run. Are you planning to sell your property before you pay off your mortgage? Are you going to start a family soon? Will there be any predictable health issues?

These will impact your income and expenses, and are necessary to consider before you go changing possibly the biggest finance loan you have.

Your monetary stream is also a major player in this scenario. Is your job foreseeable into your future? Is your pay likely to change? If you own a small business, chances are you need to consider this more carefully. You can always ask an expert for advice if you are unsure about the best avenue to take.

2. Consider additional lump sum payments

Paying a larger lump sum will reduce the amount of interest that is charged by reflecting it against a lower loan balance

Waiting out a high-interest period might prevent you from having to change your mortgage situation as you never know what the next change can bring.

With a variable loan, you can make extra repayments as you wish, whereas a fixed home loan requires a fee. By getting ahead of your mortgage and paying a larger lump sum when interest rates go up, you will reduce the amount of interest that is charged by reflecting it against a lower loan balance.

While it means you currently have to release more money from your income towards your mortgage, you will be on a faster track to paying it off. There will also be fewer dollars in your loan harvesting interest.

3. Get a fixed or split loan

An increase in mortgage interest levels means that those with a variable loan have to meet the requirement of the rising or falling rates.

This unpredictable nature might warrant some consideration, especially if rates keep going up. Depending on your loan conditions and your lender, you have the choice to change over to a different type of loan.

A fixed mortgage provides you with the stability of a set interest rate if you don't think your finances could cope with the changeable levels. However, making the switch at the wrong time can lock you into a higher-interest loan. It also means that you cannot take advantage of the lower rates that the future may bring.

Split loans are also available, which allow you to fix a portion of your mortgage at a set interest percentage whilst the rest is according to the current rate of your lender. This allows for both stability and flexibility, especially if you are wanting to benefit from low rates whilst protecting your loan against higher rates.

It is worth doing your research and taking a look at all the loan options to find the one that best suits your finances, especially if you know they are likely to change.

Talk to an expert to find the best home loan option for you.

4. Switch to a different lender

Refinancing is the process of moving your home loan to a different lender or a different loan that better suits you. There are a number of reasons for doing this, but the number one reason is to save money on your loan.

There are many benefits to refinancing your home loan, including lower interest repayments, reducing your loan term, additional loan features and the ability to access equity.

Research is key when looking at finance. Take advantage of online resources to bump up your knowledge when it comes to 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.

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