When you’re looking to get a home loan in Australia, it’s important to know how the interest rate of your home loan will impact your mortgage repayments and how much interest you will pay over the life of the loan. This can help you select the home loan and lender that is right for you and how you’ll be impacted by rate changes or by making extra repayments.
How is interest calculated on a home loan?
To look at it simply, there is a mathematical formula for working out the amount of interest you will pay on your home loan amount. Generally, interest is calculated on your loan balance daily and charged monthly.
If your remaining loan balance is $500,000 and your interest rate is 5.67% p.a., this will look as follows:
- To calculate one day of interest: (500,000 x 0.0567) / 365 = $77.67
To calculate one month’s total interest: 77.67 x 30 = $2,330.10
In this example, we are working off a regular year with 365 days and a month with 30 days (e.g. April). Some lenders will work out interest charges based on a 366-day calendar in a leap year, while others will use the standard 365-day calculation in leap years, so it’s a good idea to check how your lender does their daily interest charges and the number of days they use in their leap year!
Depending on whether you are on an interest-only or principal and interest home loan, as well as the frequency of your home loan repayments, you can calculate what your repayments will be.
Make sure to consult the product disclosure statement and target market determinations before choosing a specific loan product.
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Interest-Only Home Loans
If you get an interest-only home loan, your repayment amounts will be worked out based off the total monthly interest as calculated above.
Interest-only home loans are a loan type that allows you to make fortnightly or monthly payments of just the interest on your home loan for a set period of time. As you’ll be making interest-only repayments and not factoring in the principal amount, these are pretty specific loans, and you may end up paying more over the life of the loan with higher interest rates.
Interest-only home loans are most commonly used by home buyers building a new home or buying an investment property with a mortgage.
Principal and Interest Home Loans
The most common loan type, regular repayments on principal and interest loans, pay interest on the outstanding balance of the loan as well as the principal amount of the loan (the total amount borrowed initially). This will mean your interest payments are more consistent over the loan term, dependent on whether you are on a fixed rate or variable rate at any given time.
To figure out your monthly repayments (or fortnightly repayments, if your home loan allows for flexible repayment frequency), you can plug the details of your home loan and its annual interest rate into a loan repayment calculator.
It’s important to remember, especially with a variable rate home loan, that the cash rate influences home loan interest rates. The Reserve Bank of Australia sets this and has a run-on influence on interest rates across various products (including car loans, personal loans, bank accounts, and credit cards).
As a disclaimer, you will also tend to pay lower interest rates for owner-occupier home loans rather than investor home loans.
What about offset accounts?
Though not all home loans give borrowers access to offset accounts, many full-feature loans (especially those with variable interest rates) may offer offset accounts as a feature to those meeting the lending criteria. An offset account is an account linked to your home loan, but you are only charged interest on the difference between the offset account balance and your home loan balance.
Since the remainder of the money in your offset account is interest-free, this can be a helpful alternative to a transaction account or everyday bank account.
This is one feature you may want to look for when comparing home loans, along with other options like free extra repayments and access to a redraw facility.
Calculating interest on a refinance home loan
Once you have built up sufficient equity in your home and have lowered your loan-to-value ratio (LVR) or find yourself stuck with a too-high interest rate, you may be interested in refinancing. Refinancing can help you pay less interest in the long run, as you can move to a lower interest rate or a home loan that suits your circumstances better.
Whether you are working with a mortgage broker or looking to refinance on your own, make sure to check not just the headline interest rate of the refinance home loan but also the comparison rate. This rate is a legal requirement in Australia and calculates a more accurate depiction of the interest rate you will pay on your loan when you factor in any fees and charges.
Calculating interest on a refinance home loan works in the same way as your first home loan, but there may be a lower interest rate in play as you may have paid off more of your loan balance at this point.
