Just starting out in the property market? Interest rate terminology on your home loan can be hard to sift through.
To understand what you’re agreeing to, it’s important to understand the basics about interest rates.
What is an interest rate?
The price of borrowing money, charged on what you still owe. Your loan balance accrues interest, and the higher the rate, the more debt builds over time. It works like renting money: you pay interest so that you do not have to pay the full amount up front.
When you are approved for a home loan, that loan balance accrues interest. The higher the interest rate, the higher the debt accrued over time.
Think of it like you’re renting money. Just as you’d pay rent on an apartment, you’re paying interest, so you don’t have to pay the full amount up-front.
How do interest rates work?
Interest applies to the part of the loan still outstanding, not the amount you originally borrowed. So as the balance comes down, the interest you pay comes down with it, provided the rate itself stays the same. A rate change moves the figure independently of the balance.
As the overall balance of your loan decreases, the amount of interest you pay will decrease if the interest rate stays the same. This is because the interest rate is a percentage of the loan’s balance.
In other words, the interest rate applies to the amount of the loan that is still outstanding.
What are the types of interest rates?
Three. A variable rate can change at the lender’s discretion, typically when the Reserve Bank of Australia moves the official cash rate. A fixed rate holds for an agreed period, usually one to seven years. A split loan fixes part of the balance and leaves the rest variable.
Variable
A variable interest rate can change at the lender’s discretion. If the Reserve Bank of Australia alters the official cash rate due to a fluctuating economy, your lender could change your loan rate accordingly. The official cash rate is the rate at which banks borrow money.
These loans are very popular in Australia because of their flexibility. Borrowers can switch providers without incurring a break cost fee that often apply to fixed rate loans. And, you could reduce the amount of interest you pay.
For example, the 100 per cent offset account is a feature of variable interest rate loans. This allows you to link a separate savings account to your home loan account, which offsets the home loan balance. You are then charged interest on the difference between the two accounts, says Canstar.
Fixed
A fixed interest rate will remain the same throughout an agreed upon period of the time, usually one to seven years. However, fees may apply if you want to refinance your loan during the term.
Split
Split interest rates have some fixed and some variable portions. This means you can lock in part of your home loan to have a fixed interest rate, while another portion of it has a variable interest rate.
How we can help you
There are pros and cons to any type of interest rate you choose. To learn more about which type of home loan is suitable for you, contact our team today and we’ll guide you through the entire loan process.