When choosing a home loan, it is important to find the right interest rate option to suit your situation. But with so many offers available from so many lenders, finding the right one can be overwhelming.
The basics
Put simply, a home loan interest rate affects how much interest is charged to your home loan over one year. It’s shown as a percentage and applies to the outstanding amount of your loan (excluding any offset amounts).
Why do interest rates change?
While lenders like banks set their own home loan interest rates, in Australia these are often impacted by movements of the official cash rate set by the Reserve Bank of Australia. Over time, home loan interest rates go up and down based on economic trends like inflation and growth. Of course, rates you see advertised can also vary. Banks will offer different rates for different types of home loans and different levels of lending risk.
What are the different types of interest rates?
There are two types of interest rates – fixed and variable.
When shopping for a home loan, you’ll usually have the option to choose between fixed and variable rate options. Sometimes you can split your borrowing across both options. Getting to know what fixed and variable options mean can help you make a more informed and confident decision about what’s right for you.
Fixed Interest Rates
Fixed interest rates will stay the same for the full term of the loan agreement, generally between 1 to 5 years and you’ll pay the same amount at each payment cycle (fortnightly or monthly).
Variable Interest Rates
With variable interest rates, your loan rate and repayments will go up and down depending on the interest rate changes. This can be helpful if rates go down as the amount of interest you pay will get reduced, but they may also go up making budgeting a challenge.
Another benefit of choosing variable rate loans is that it usually gives you the flexibility to make extra repayments or repay your loan in full ahead of the loan term, without paying any additional fees.
How do you reduce interest paid?
The primary way to reduce monthly interest charged on your mortgage is to utilise your offset or redraw accounts, as money held in these accounts will reduce the balance that interest is charged on every month.
For example, say you have a $500,000 mortgage balance and have $10,000 in your redraw account. This would mean that your monthly interest is only being calculated on a balance of $490,000.
However, not all offset and redraw accounts are equal - while some are free, others come with a monthly fee, so be sure to weigh up the benefits to ensure it's right for you.
Interest rates vs. comparison rates
The interest rate isn’t the only cost borrowers pay – most lenders also charge fees. That’s why it’s important to keep your eye on a loan’s comparison rate when shopping for the best deal.
There are clear rules for how lenders calculate their loans’ comparison rates. This ensures they provide more of an “apples to apples” comparison.
Comparison rates can make it easier to understand your home loan as they include relevant cost factors along with the interest rate. These factors can include:
- the interest rate
- most fees and charges
- repayment frequency
- loan term
- the amount of the loan
Comparison rates are still represented as a percentage but provide a clearer way for you to work out the true cost of a home loan over time.
Ask the specialists
Remember there are no silly questions. Interest rates and lending can get complicated. Reach out to your local Richardson & Wrench office to be put in touch with a reputable broker in your area who can take you through the process and explain everything along the way.
Be sure to check out Shore Financial, Australia’s number 1 independent mortgage brokerage for various calculators to help you plan your next move.