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Comparing Interest Rates
Interest rates are hot topic when it comes to home loans, and for good reason. First home buyers are often shocked at how much they’ll pay on interest over the life of the loan.
|4% interest rate
Total paid: $633,404
|3.5% interest rate
Total paid: $600,748
|Total interest paid: $233,404||Total interest paid: $200,748|
While a low interest rate is a clear way to save, it’s not always a money-saving guarantee. We’ll get to other factors that can affect your savings, but first let’s talk more about interest rates.
Variable Interest Rate
Variable interest rates fluctuate in line with market interest rates. The rate at the start of your loan is likely to change, and could go up or down. Your lender will give you notice of any applicable rate changes before they go into effect.
Variable rate home loans tend to be more flexible. Borrowers typically aren’t locked into a term, as they are with fixed rate loans. You may also gain access to a wider range of features, like the ability to make unlimited extra repayments and pay down your loan more quickly.
Advantages of a variable interest rate:
- Benefit when interest rates are low
- Variable rate loans tend to be more flexible
- Option to make unlimited extra repayments (depends on the loan)
Disadvantages of a variable interest rate:
Your rate could go up at any time
More difficult to know what your repayments will be
Fixed Interest Rate
With a fixed interest rate, you can secure your interest rate for a set period of time. For example, you may be able to fix the rate for 1, 3, or 5 years. When your fixed term ends, you may have the option of re-fixing it, or your loan will automatically revert to the lender’s standard variable rate.
Advantages of a fixed interest rate:
- Know your repayments, which makes it easier to budget
- Your rate stays the same regardless of what the market does
Disadvantages of a fixed interest rate:
More restrictions: there is usually a cap on additional repayments and limited, if any, redraw facility
Cannot benefit from a market rate drop
Fees may apply if you wish to switch lenders or pay off your loan during the fixed term.
Split Interest Rate
Can’t decide which interest rate is for you? Consider splitting your loan by making part of it fixed and part of it variable. Borrowers can generally choose how they’d like to split the loan; for example, you could make 30% of it fixed and 70% variable.
Split rate loans can be a good option for people who are buying when interest rates are low. These loans allow you to benefit from a low interest rate while including the flexibility of a variable rate loan.
When you split your loan, you essentially have two loans; each portion will have different features, applicable fees, and other requirements. By splitting your loan, you may be affected by the advantages and disadvantages of both fixed and variable loan types.
When comparing home loans, you may notice that many lenders display two rates for the same loan: a standard rate and a comparison rate.
The comparison rate is a way that lets borrowers compare apples with apples. Home loans come with different fees and charges, which can affect the true cost of a loan.
A comparison rate includes these fees and charges along with the interest rate, so you can more accurately compare. For example, a home loan with a lower interest rate isn’t always the best choice, as its fees and charges may make it more expensive.
What makes interest rates higher or lower?
Most lenders set standard fixed and variable interest rates, but these rates can differ across loan types. Here are a few factors that may affect a lender’s interest rates:
- Type of borrower: investor interest rates tend to be higher than those for owner-occupiers
- Fixed term: Longer fixed terms often have slightly higher interest rates
- Features: A loan packed with features may also charge a higher interest rate
Comparing Home Loan Features
We’ve already touched on a few different features, such as extra repayments and redraw facilities. But what do those features mean and how can they benefit you?
Let’s take a look at some of the most common home loan features.
A home loan may structure its repayments as ‘principal + interest’ or ‘interest only.’ Your principal is the amount that you originally borrowed, and the interest is the amount charged on top.
When you pay down principal + interest you are reducing your balance and paying off your loan. When you pay interest only, you are maintaining your loan but the principal is not getting any smaller.
Extra repayments are any payments above and beyond your required repayments. Making extra repayments can help you pay down your loan faster.
Variable home loans often allow you to make unlimited repayments, while fixed home loans may put a cap on repayments (usually around $10,000 per year) or not allow them at all.
With a fixed home loan, there may also be a fee for paying off your loan early.
A redraw facility lets you access any extra repayments that you have made. You can ‘redraw’ these funds into a nominated bank account to use as needed.
Some home loans offer a redraw facility at no extra charge, while others may charge a fee or require a minimum redraw amount.
Fixed loans may not offer a redraw facility at all.
An offset account is a transaction account that is linked to your home loan. Any money you keep in that account helps reduce the interest you pay.
When interest is calculated, the money in your offset account is counted as part of your principal balance. Therefore, interest is based on your principal minus the money in the offset.
Flexible repayment options let you control your repayments. Many lenders offer the ability to make weekly, fortnightly, or monthly repayments. You can save money by making more frequent repayments.
Here’s how repayment frequency can affect a $400,000 loan with 4% interest over a 25 year term.
Total paid: $633,404
Total interest paid: $233,404
Total Paid: $633,074
Total interest paid: $233,074
Total Paid: $632,932
Total interest paid: $232,932
If you do not have a 20% deposit, you may be liable for Lenders Mortgage Insurance (LMI). This is a payment you make to protect the lender in the event that you aren’t able to make your repayments.
With a family guarantee, you can use the equity in an immediate relative’s home as security against a portion of your loan. This can help you reduce pricey LMI without having to scrape together more money for a deposit.
Lenders (particularly banks) may offer financial packages alongside your home loan. This may include a credit card and transaction account with the lender’s financial institution in exchange for discounted fees or interest rates on your home loan.
These packages often come with an annual fee, so it’s worth considering whether your savings outweigh the cost.
More features do not necessarily mean a better home loan. Whenever possible, choose a loan that offers features that you’ll actually use.
When comparing home loans you’re not just looking at financials; you’re comparing lenders too. There are a wide range of lenders on the market, so you may not be familiar with all of them.
Smaller boutique lenders can often offer more personalised customer service, while big banks have the advantage of being a known quantity. Here are a few things to consider when comparing home loan lenders:
- Performance: Read up on a lender’s performance to find out how they stack up against other lenders. This can include any awards the lender has won.
- Reputation: Know anyone who has used this lender? Ask them about their experience.
- Accessibility: Some lenders are online-only these days, with no physical presence. While this can be great for some borrowers, it is uncomfortable for others.
- Financial services: Prefer to keep all of your finances together? You may want a lender who can also offer you a banking or superannuation package.
Home Buying Goals
Your home buying goals can impact what to look for when comparing home loans. Borrowers who want a new construction are likely to have different priorities than an investor shopping for residential properties.
Borrowers who aren’t interested in offset accounts and redraw facilities may be better off with a basic home loan, while those who are more financially savvy may want all the trimmings.
If this all sounds like a lot to get your head around, don’t worry! It can be. That’s why many Australians choose to work with a mortgage broker. Using a professional doesn’t cost you anything, but it can result in considerable savings.
A good mortgage broker will listen to your home buying goals and work to find a home loan that fits your needs, so you can focus on finding your new home.