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Demystifying home loan interest rates

A big decision you’ll have to make on your journey to finding the right home loan, is whether you want a fixed and variable interest rate, or a combination of the two.

Over the life of your home loan, the interest you will pay adds up. For example, if you repay a $500,000 mortgage with an interest rate of 4% over 20 years, the total interest paid will be more than $220,000. That’s why it’s a decision that matters.

Interest rates are funny things. Not only can they mean different things (sometimes they mean you earn money and sometimes they mean you pay money), they can change over time. Most often, this change occurs when the Reserve Bank of Australia’s (RBA) alters the cash rate.

If you have no idea what we are talking about, that’s ok. You’re not the only one. Each month (except January) the RBA board makes decisions about Australia’s boarder economic environment, including the cash rate, which is the interest rate that banks apply to one another on overnight loans. If RBA change the cash rate, banks may also change the variable rates of their products. This may affect your mortgage repayments depending on the type of rate you select when you take out your home loan.

Fixed interest rates

A fixed interest rate means you will pay the same interest rate and therefore the same repayments for a defined period. For example, a bank may offer you an interest rate of 4.5% p.a. for a period of three years. This may be a good option if you’d like certainty about your repayments or if you think interest rates will rise. Keep in mind that often home loans with a fixed interest rate are less flexible than variable rate loans. This may mean you can’t pay off extra over time, or redraw on extra repayments you make.

Variable interest rates

A variable interest rate means your interest rate and repayments are likely to change when the RBA changes the cash rate. You would choose a variable interest rate over a fixed interest rate if you believe rates will go down. If interest rates go down, so will your repayments. Variable rate home loans are often more flexible than fixed rate home loans, allowing you to make extra repayments to pay off your mortgage sooner and redraw these amounts if you need to.

The rate that’s more than just the rate.

When looking at the different interest rates banks are offering, you are likely to come across Comparison Rates. Comparison rates are there to help you easily compare loans from different lenders. They represent the overall cost of the loan, including the interest rate (fixed or variable) and other upfront and ongoing fees involved in the loan.  All home loan advertising must show the comparison rate. For example, a home loan may be advertised with an interest rate of 3.82% p.a. but the comparison rate is 4.17% p.a. when all the other fees and charges are considered.

Many people choose a combination of a fixed and variable home loan to achieve a ‘best of both worlds’ situation. Yes, this is possible! This allows the borrower to enjoy the benefits of interest rates falling but also gives certainty over a portion of the loan.