Mortgage Interest Rates and How They Work.

Mortgage Interest Rates and How They Work, Your Mortgage Interest Rates and How they Work, Paul Hill RealtyPaul Hill Realty Hope Island is dedicated to assisting clients with Property Sales and Property Management across the Northern Gold Coast. 

As part of our commitment to keeping you informed, we want to share this 2-part article. The first part is on ‘Interest Rates and How they Work’, and in the next article we will cover ‘Fixed vs Variable Rate Home Loans and What’s the Difference?

Mortgage Interest Rates and How They Work.

Trying to make sense of the mortgage jungle? Not sure if a fixed rate or variable rate home loan is right for you?

Here we’ll explain the difference between fixed and variable rate home loans. It’s important because the interest rate you pay has a big impact on your home loan repayments over time.

Then you can decide which works best for you, fixed and variable rate home loans.

Key points we’ll cover;

  • How do interest rates work?
  • What are principal and interest payments?

Before we look at the differences between fixed and variable rate home loans. We need to go back to basics and outlining what interest rates are and how they are calculated.

Interest Rates and how they work.

When a Lender lends you money they need to make a profit on the money they lend you and this is the Interest Rate.

Banks and other lenders base the interest rate for your home loan on the rate they must pay the Reserve Bank of Australia (RBA). As the RBA is who is loaning the Lender the money. This is called the RBA’s cash rate. It’s a chain of money lending with the RBA at the top and you at the bottom.

When you start researching home loans, you’ll see the interest rate listed next to the name of the loan as a percentage, like this: 2.09% p.a. The p.a stands for per annum, which is the interest rate you will pay on the loan over a year.

You want to look for the comparison rate, which includes the interest rate as well as all the fees and charges you have to pay with the loan. With these added on, the actual rate is a little higher, for example: 2.12% p.a. comparison rate.

When you take out a loan with a lender there are two components: 

  • The principal is the total amount you are borrowing.
  • The interest is the annual amount you are charged for borrowing the principal.

When you make your regular mortgage repayments, they go towards these two components. The interest rate has the greatest impact on your monthly repayments and on the overall cost of your home loan.

Example: Here are two home loans, one with an interest rate of 2.33% vs a rate of 3.0%.

Our calculation is based on a 25-year loan term (or length) for a loan of $500,000.

  • On a loan with an interest rate of 2.33% p.a. you would be paying $2,211 per month for a total of $163,155 interest over 25 years.
  • On a loan with an interest rate of 3.0% p.a. you would be paying $2,381 per month for a total of $214,317 interest over 25 years.

In this case, if you took the loan with the 3.0% p.a. rate you would have paid $51,162 more in interest over the life of the loan.

As you can see, a small difference in interest rates adds up over time, so securing a lower rate can help save you thousands of dollars in the long run.

What are principal and interest payments?

If you’re paying principal and interest, your monthly repayments pay a portion of the original amount borrowed (the principal) as well as the interest charged on the loan. This is the fastest way to pay off your home loan, although you need to be sure it suits your specific circumstances.

If you choose an interest-only loan, your repayments will only pay off the interest on the loan, not the principal, for a set period—often between 3 and 5 years.

This can be helpful for home buyers looking to benefit from lower repayments in the shorter term, however after the set period the loan will revert to principal and interest payments. Once that happens, your repayments will be significantly higher, and it may take you longer to pay off your home loan.

In the next article, we will look at ‘The Differences Between Fixed and Variable Rate Home Loans’.

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If you are looking for an experienced property manager with your best interests at heart – look no further than Paul Hill Realty Hope Island! You won’t find a team that is more respected, reliable, and trusted in residential property management.

Paul Hill Realty office is located at Hope Island, we manage residential properties anywhere on the Northern end of the Gold Coast. Paul Hill Realty Hope Island is your best choice in property management and Sales.

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Disclaimer: Blogs are written expressly for education purposes and content is based on the opinions of the authors or as otherwise cited. This information does not constitute legal, tax or financial advice and you should always seek professional advice in relation to your individual circumstances.