A change in home loan interest rates can affect more than your monthly repayments. It can also influence the total interest paid over the loan term, the loan amount a lender may be willing to offer and how much room remains in your household budget.
Ironbark Group Australia explains how home loan rates affect repayments and borrowing power, why fixed and variable rates behave differently and which fees, features and lending criteria should be considered when comparing home loans in Australia.
What influences your home loan interest rate?
Home loan interest rates are set by individual lenders and can be influenced by changes to the Reserve Bank cash rate, lender funding costs, competition and the risk associated with a particular loan. This means two borrowers applying for a similar loan amount may receive different rates.
When comparing home loans, the rate available to you may depend on:
| Factor | How it may affect your interest rate |
|---|---|
| Reserve Bank cash rate | Changes to the cash rate can influence variable home loan rates, although each financial institution decides whether and when to adjust its rates. |
| Loan purpose | Owner-occupier loans and investor home loans may have different interest rates and eligibility criteria. |
| Repayment type | Principal and interest repayments may be priced differently from interest-only payments. |
| Loan-to-value ratio | Your loan-to-value ratio, or LVR, compares the loan amount with the property value. A higher LVR may affect the available rate and whether lenders mortgage insurance applies. |
| Fixed or variable rate | A fixed rate home loan keeps the interest rate unchanged for an agreed fixed period. A variable rate home loan can move when the lender changes its rates. |
| Loan product and features | Features such as an offset account, repayment flexibility and loan package features may affect the rate, fees and overall cost of the loan. |
The lowest advertised rate is not automatically the most suitable option. Eligibility criteria, ongoing fees, loan features and the comparison rate should also be reviewed before choosing a loan product.
How do home loan interest rates affect your repayments?
Home loan interest is calculated on the outstanding loan balance. On a variable rate home loan, an interest rate rise will generally increase the required monthly repayment, while a rate reduction may lower it. The exact change depends on the loan contract, remaining loan term and how the lender applies the new rate.
For example, consider a $600,000 home loan with a 30-year loan term and principal and interest repayments:
- At 5% interest, the estimated monthly repayment is about $3,221
- At 6% interest, it rises to about $3,597
- At 7% interest, it increases to about $3,992
In this example, a two-percentage-point increase adds around $771 to the monthly repayments. The difference also builds over the full loan term because interest is charged on the remaining loan balance each month.
The effect will vary according to the loan amount, repayment type, remaining term and whether you use features such as an offset account or make additional repayments. Fees and future changes to variable interest rates can also affect the total cost.
You can use Ironbark’s online home loan calculators to test different loan amounts, interest rates and repayment periods. Calculator results are estimates only and do not represent conditional approval or a loan offer.
Example calculations assume monthly principal and interest repayments over 30 years and exclude fees, offset balances and future rate changes.
How do home loan interest rates affect borrowing power?
Borrowing power is the loan amount a lender may be prepared to offer after assessing your income, expenses, debts and personal financial circumstances. Home loan interest rates are part of this assessment because they affect the monthly repayments used to test whether you could afford the loan.
When rates rise, the estimated repayments on a proposed home loan also increase. This can reduce borrowing power, even when your income and deposit have not changed. Lower rates may improve borrowing capacity, although the result still depends on the lender’s eligibility criteria and assessment process.
- Lenders may consider factors such as:
- Your income and employment arrangements
- Regular living expenses
- Credit cards and other loan repayments
- The requested loan amount and loan term
- Whether the loan is for an owner-occupied home or investment property
- Your deposit and loan-to-value ratio
- The proposed repayment type
- The lender’s assessment interest rate
APRA requires banks and other authorised deposit-taking institutions to apply a mortgage serviceability buffer of at least three percentage points above the loan rate when assessing residential mortgage applications. This helps test whether borrowers could continue meeting their repayments if interest rates or expenses increase. Other lenders may apply their own assessment policies.
A conditional approval or borrowing estimate is not a guarantee of the final loan amount. Changes to home loan rates, your financial situation or the selected property could affect the lender’s final decision. For a first home buyer, reviewing borrowing power early may help set a more realistic property budget.
Fixed versus variable home loan rates
Fixed and variable rates affect repayments in different ways. The right option depends on your financial situation, preferences and how much certainty or flexibility you want from the loan.
A fixed rate home loan keeps the interest rate unchanged for an agreed fixed rate period. This generally means your required repayments remain consistent during that time, which can make budgeting easier. However, fixed rate loans may place limits on additional repayments and could involve break costs if you refinance, repay the loan early or make certain changes during the fixed term.
Once the fixed period ends, the loan will usually move to a variable rate unless another arrangement is made. The new rate and repayments may be higher or lower than those that applied during the fixed period.
A variable rate home loan has an interest rate that the lender can change. If variable interest rates rise, your required home loan repayments may increase. If rates fall, repayments may decrease, although this depends on the lender and the terms of your loan contract.
Variable home loans often provide greater repayment flexibility and may include features such as an offset account or redraw facility. These features, along with the interest rate, ongoing fees and repayment conditions, should be considered when comparing fixed and variable rates.
What should you compare besides the interest rate?
The advertised interest rate is only one part of a home loan’s cost. Before choosing a product, review how the rate works alongside the loan’s fees, features and repayment conditions.
- Comparison rate: This combines the interest rate with most standard fees and charges to provide a broader indication of the loan’s cost. It does not include every possible fee or reflect features such as an offset account.
- Ongoing fees: Package, account and annual fees may reduce the benefit of a discounted interest rate.
- Loan term: A longer loan term can lower monthly repayments but generally increases the total interest paid over time.
- Repayment flexibility: Check whether the loan allows additional repayments and whether limits or fees apply.
- Offset and redraw features: An offset account may reduce the loan balance on which interest is calculated, while a redraw facility may provide access to eligible additional repayments. Fees, access conditions and other rules vary between lenders.
- Fixed-rate conditions: Review the length of the fixed period, restrictions on additional repayments and potential break costs.
- Eligibility requirements: The advertised rate may only apply to eligible borrowers, particular loan purposes or loans within a specified loan-to-value ratio.
Comparing the complete loan offer can give you a clearer picture than looking at the interest rate alone. The most suitable option will depend on your loan amount, repayment type, financial situation and longer-term plans.
What can you do when home loan interest rates change?
A change in home loan interest rates is a useful prompt to review your existing home loan rather than assuming you need to change lenders immediately. Start by checking your current rate, monthly repayments, loan balance, remaining loan term, fees and available features.
You can then compare your current loan with other home loan rates in the market. This may help you identify whether your financial institution is still offering a competitive rate or whether you could be paying a home loan loyalty tax.
It may also be worth asking your current lender whether a lower interest rate or different loan product is available. Staying with the same lender could avoid some refinancing costs, although any new rate, fees, features and conditions should still be reviewed carefully.
Where your existing loan no longer suits your financial situation, you could explore refinancing options. Refinancing may change your repayments or loan structure, but discharge fees, application costs, the remaining loan term and any fixed-rate break costs should be considered before proceeding.
A lower interest rate does not automatically make refinancing worthwhile. The potential savings should be compared with the total cost of changing loans and how long you expect to keep the new home loan.
Find out more from an Ironbark Group Australia mortgage broker
Home loan interest rates are only one part of choosing a suitable loan. Your repayments and borrowing power can also be influenced by the loan term, fees, repayment type, features and lender eligibility criteria.
Ironbark Group can help you compare home loan options and understand how different rates and loan structures may affect your financial situation.
To discuss buying, investing or refinancing, contact the team at Ironbark Group Australia and speak with a mortgage broker.