Understanding home loan interest rates
Choosing a home loan means finding an interest rate option that fits your situation. With so many lenders and offers available, it can feel like a lot to take in.
How are rates set? What types are there? Why do they vary? And what does ‘comparison rate’ mean? This guide walks you through the basics, so you can feel more confident as you move through the home buying process.
How are interest rates decided?
Two key factors typically influence interest rates:
1. What it costs the lender to provide your loan
Lending money comes with a cost, influenced by a mix of local and global factors. Because each lender’s funding costs are different, interest rates can vary.
One key influence is the rate banks and investors charge each other to lend money, known as the Bank Bill Swap Rate. When this changes, it can impact customer rates.
This is why interest rates don’t always move in line with the Reserve Bank of Australia’s cash rate. Other factors, like market competition and economic conditions, also play a role.
When funding costs change, lenders may review and adjust their interest rates accordingly.
2. The level of 'risk' to the lender
Another key factor is risk. Generally, the higher the risk, the higher the interest rate may be.
Lenders look at things like your deposit compared to how much you want to borrow, known as the loan to value ratio (LVR). A lower ratio usually means lower risk, which is why a strong deposit can make a difference.
They’ll also assess your ability to repay the loan, including your credit history and current financial position. These factors help determine if a loan can be offered, and at what rate.
At Pepper Money, we take a personalised approach. We assess each situation on its own to find options that fit, while helping keep repayments manageable.
What are the different types of interest rates?
There are two types of interest rates – fixed and variable.
Fixed Interest Rates
With a fixed rate, your interest rate stays the same for an agreed period, usually between one and five years. During this time, your repayments stay consistent, which can make budgeting easier.
At Pepper Money, fixed rate terms can extend up to 10 years, and we don’t charge break fees. Learn more about our fixed rate home loan.
Variable Interest Rates
With a variable interest rate, your interest rate can rise or fall over time. This means your repayments can change as rates move.
If rates go down, you could pay less interest. If they go up, repayments may increase, which can make budgeting less predictable.
Tip: Not all rates are advertised. Some lenders offer discounts or alternative options, such as interest-only periods. It’s worth asking about all available options so you can choose what suits you best.
How can you reduce the interest charged on your mortgage?
One way to reduce the interest you pay is by using an offset or redraw account (if available). The balance in these accounts reduces the amount of your loan that interest is calculated on.
For example, if your loan balance is $500,000 and you have $10,000 in your redraw account, interest is calculated on $490,000 instead. This assumes a 100% offset account where amounts in that account offsets the interest for the entire balance of the loan.
Offsets and redraw facilities can vary. Some are free, while others come with fees, so it’s important to weigh up whether they work for you.
What is a comparison rate?
A comparison rate helps you understand the overall cost of a loan. It includes the interest rate as well as certain fees and charges associated with the loan.
While it covers common costs such as establishment and ongoing fees, it doesn’t include every possible fee. Its purpose is to make it easier to compare different loan options more accurately and to help you make an informed decision.
FAQs about home loan interest rates
Interest rates are typically influenced by a lender’s funding costs and the level of risk. Funding costs can be affected by local and global market factors, including rates banks charge each other. Risk is assessed based on factors like your loan to value ratio, credit history and overall financial position.
There are two main types of home loan interest rates: fixed and variable. A fixed rate stays the same for an agreed period, which can help with budgeting. A variable rate can rise or fall over time, meaning repayments may change.
With a fixed interest rate, your rate stays the same for a set period, usually between one and five years, although some lenders offer longer terms. During this time, your repayments remain consistent, which can make it easier to plan your budget.
With a variable interest rate, your rate can increase or decrease over time. This means your repayments can change. If rates go down, you may pay less interest, but if they rise, your repayments may increase.
You may be able to reduce the interest charged by using an offset or redraw account. The balance in these accounts reduces the portion of your loan that interest is calculated on, which can lower the total interest you pay over time.
A comparison rate is designed to show the overall cost of a loan by combining the interest rate with certain fees and charges. It helps you compare different loan options more accurately, although it does not include every possible fee.
Where can I get more information?
There’s no such thing as a silly question. If you’re unsure, ask. Here are a few practical ways to learn more:
- Speak to a broker who can guide you through your options, or get advice from a licensed financial or tax adviser
- Check online comparison sites like MoneySmart, Finder, Canstar or Comparethemarket for reviews and insights.
Contributor | Anthony Moir, Treasurer
Anthony joined Pepper Money in February 2021 as Treasurer. With over 25 years of experience in treasury and debt capital markets, he has worked with a diverse range of bank and non-bank lenders.
Published by Pepper Money. Read our Editorial Policy to learn how we create and review content.
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