The interest rate on your mortgage is the rate at which the bank will charge you interest on the amount you have borrowed. The rate is expressed as an annual percentage, but lenders calculate interest on a daily basis so that the interest compounds.

A range of factors can affect the amount you repay your bank including:

Fixed vs variable rates
Principal and interest repayments
Advertised rate vs. comparison rate
Frequency of payments

Fixed vs. variable interest rate

Before you decide on a home loan, it’s a good idea to decide what type of interest rate you want to pay. In the Australian mortgage market, there are three main options:

Fixed rate loan
Variable rate loan
Split loan

Which loan should I take out? Fixed or variable?

Fixed vs variable is one those crystal-ball questions potential home owners grapple with before they take out their first loan. There’s no right or wrong answer - it really depends on how you want to manage your finances.

If you’re someone who likes the security of knowing how much you need to repay each month, then a fixed rate could be right for you. If you’d rather keep your options open and pay market rate, regardless of the inevitable fluctuations, then a variable rate could be more your cup of tea.

Fixed home loan

A fixed home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years.

The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term.

There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

TIP: If you opt for a fixed rate loan, find out what variable rate the loan will revert to afterwards before signing up. You might find it’s a lot higher than competitive rates on the market.

Pros Pre-set repayments each month can provide peace of mind Potentially saves you money if the variable rate increases during the fixed term Helps you plan for monthly expenses	Cons Potentially costs you money if the variable rate falls, and fees may include break fee, legal fee and settlement fee Less flexibility: Some loans don’t allow additional repayments or include an offset account Can attract high interest rates after the fixed rate period

Variable home loan

A variable home loan has an interest rate that can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia (RBA), so while thecash ratemight go down, your bank may decide not to follow suit, although they do broadly follow market conditions.

One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

Pros Can save you money if your bank’s interest rate drops Flexibility: Loans typically offer more options such as an offset account and redraw facility Switch loans at any time with minimal cost	Cons Repayments will go up if your bank’s variable rate rises Uncertainty: Harder to budget for on a monthly basis as repayment could change Higher repayments might put people into mortgage stress

Split rate home loans

A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates.

A split loan can be a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account.

Of course, as with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the percentage of your loan that you didn’t fix.

‘Interest-only’ vs ‘principal and interest’ repayments

Most banks will ask you to pay back both the amount you owe and the interest charged – known as ‘principal and interest’ repayments.

However, some lenders will give you the option of making ‘interest only’ payments for a limited amount of time. While interest-only payments are lower on a monthly basis, ultimately they cost significantly more in the long run because you aren’t reducing the principal amount you owe the bank.

Conversely, by paying down the principal on your loan, your monthly repayments might start higher but they will reduce over time to a point where you’ll become mortgage-free one day and own your home outright.

Example: Jackie and James decide to move onto interest-only repayments for the first five years of their $500,000 mortgage while they take time out to travel overseas. Doing so reduces their monthly repayments from $2,684 to $2,083 – a ‘saving’ of $601.

After five years however, their monthly repayments will increase to $2,923 for the remainder of their 30 year loan, which is $239 more than what they would have paid each month if they had kept paying principal and interest. As a result of the interest-only period, Jackie and James will also pay their bank an extra $35,606 in interest.

Did you know? Two thirds of all investor loans are interest-only loans (source: ASIC)

Why go interest only?

Interest only repayments are popular with investors who want to minimise the amount of equity tied up in a property. This frees their money up so they can invest it elsewhere while still benefiting from any capital gains the property might have.

Negative gearing rules in Australia mean that some investors can write off the interest paid on their investment, if their investment is running at an overall loss.However, anyone considering investing in the property market should do their research thoroughly and talk to a financial expert before committing.

Advertised rate vs. comparison rate

Ever wondered why banks display two different interest rates when advertising a home loan?

The first rate is typically the bank’s ‘advertised rate’ which is the percentage of interest they will charge you on your loan.

The second rate, known as the ‘comparison rate’, factors in most of a loan’s fees and charges to help Australians understand its overall cost, and make a more balanced comparison of home loan products.

Comparison rates are calculated using an industry-wide formula, based on a $150,000 loan over a 25-year period, which all lenders are legally required to display alongside their advertised interest rate.

Products that have a significantly higher comparison rate compared to their advertised rate are likely to include extra costs such as high application fees or an interest rate that increases over time, such as a discounted rate that reverts to a higher rate after the promotional period is over. It’s important to go through the fine print of any loan for yourself.

Example: Harvey finds a great mortgage at a competitive rate of 3.99% but the comparison rate is listed at 5.01%. The comparison rate tells him there’s a catch but where is it? The upfront fees are reasonably priced at $400 and there are no ongoing fees, but after a bit of investigating he discovers the rate of 3.99% applies for the first 3 years only, after which his variable rate will jump up to 5.24%.

Harvey decides to compare this to a home loan with an advertised rate of 4.45%, with no hidden fees and a comparison rate that matches the advertised rate. Over the life of his $500,000 home loan, Harvey discovers that he will save over $58,000 by selecting the loan with the higher advertised rate, but no hidden catches.

Repayment frequency

Many mortgage holders don’t realise that the frequency of your mortgage repayments can make a noticeable impact on how much you’ll pay your bank in interest over the life of your loan. Banks calculate your interest on a daily basis, so if you opt to pay fortnightly instead of monthly, that means for two weeks of each month you’ll be charged slightly less interest because you’ve already paid off part of your monthly repayment. It will only amount to a few cents at a time, but add it up over 360 months in a 30 year loan and it starts to turn into dollars.

There is, however, another much bigger trick to paying fortnightly. Many lenders calculate fortnightly payments arates half of your monthly repayments, but because there are more than four weeks in most months, over the course of the year you’ll effectively end up making one extra monthly repayment (fun fact – in a 52-week year, there are 12 months, but 26 fortnights). Ultimately this means you’re tricking yourself into making higher repayments, but it’s often a trick worth playing because it could save you thousands in the long run.

$500,000 home loan at 6%	Fortnightly (half of the monthly repayments)	Monthly
Repayments	$1,499	$2,998
Total interest paid over 30 years	$455,131	$579.191

2021 Home Loan Guide