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Understanding home loan interest rates

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As interest rate has a big impact on your mortgage repayments, it’s crucial to understand the different types of interest rates & how they work.

Your loan repayments are comprised of these two parts: principal repayments and interest repayments. The interest rate has the greatest impact on your monthly repayments and on the overall amount you pay back on your home loan. That’s why it’s imperative to understand how interest rates work and how they can affect your mortgage. Here’s a few important things to take note of:

How is interest calculated on a home loan?

As mentioned, interest will be charged when you take out a loan. This is usually expressed in percentage terms, called the Annual Percentage Rate or APR. Your lender will take the amount of your loan and multiply it by your interest rate. They will then divide that amount by 365 days or 366 days in a leap year. Keep in mind that APR is calculated per year.

As an example, you have a loan or a principal amount of $200,000, and your interest rate is at 4%. Your interest repayment for one day would be calculated using this formula: ($200,000 x 0.04) ÷ 365=$21.91.

The formula will be simply (principal x rate) ÷ time = interest.

If you want to know how much you pay in interest in a month, you just need to change the time into a monthly rate by dividing it by 12. You can use our home loan calculator to get a better overview of your home loan, and to also explore your home loan repayment options.

What affects interest rates?

Interest rates often change as a result of changes in the lender's cost of funding and in the Reserve Bank's cash rate. Other factors also affect the amount of your interest repayments such as:

  • Loan Purpose: Owner occupied vs InvestmentAs the name suggests, an owner-occupied loan is a type of loan you obtain for the purpose of buying a home. An investment property loan is taken out to buy a property you intent to rent out. The key difference between the two is the interest rate. Investment loans often have higher interest rates than owner-occupied loans.
  • Interest Rate Type: Variable vs Fixed. 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 loan to include both variable and fixed interest components

  • Loan Repayment Type: Principal and Interest vs Interest-only. If you choose a Principal & Interest loan, you will repay some principal each month as well as the interest. This is the most common option. On the other hand, you can agree with your lender to switch to Interest-only repayments, where you only pay the interest on your loan for a set period of time and do not pay off the principal. While this option has lower repayments, your repayments will increase once the interest-only term ends, and you could end up paying more interest over the life of you loan.

  • Principal Amount: The amount you borrow will obviously have a big impact on your repayments. The larger amount you borrow, the more home loan interest you need to repay.

How to reduce interest paid?

Making extra repayments towards your home loan is one way to reduce the overall cost. The more frequently you make repayments, the less total interest you will pay.

Another way to reduce the interest paid is with our offset sub-account. A loans.com.au offset sub-account is a sub-account within your home loan account where you can deposit your salary, and rental income. . You can then redraw the funds from the loan when you need them if you made extra repayments towards your mortgage.

When calculating your home loan interest, your home loan balance is reduced by the amount you have in your offset sub-account. This means you'll pay less interest.

As an example, if you have a loan balance of $300,000 and a $20,000 in your offset sub-account, you will be charged interest on only $280,000. This is because $300,000 - $20,000 = $280,000.

Shopping around and comparing loans will help you get the best home loan rate in Australia. You can use our handy home loan calculator to determine how much interest you will need to pay on loans of various sizes, interest rates and lengths.

Compare our home loan interest rates and features to find the best home loan that is right for you.

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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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