Interest rates

Pick a rate that's in your best interest

Interest rates get a lot of attention and for good reason: they determine the cost of your home loan and what you pay back each month. Even a small difference in interest rates can make a big difference to your repayments.

Types of interest rates

The Reserve Bank of Australia sets the 'cash' interest rate, which is reviewed every month. Credit providers set their own rates and can choose to increase or decrease the rates in line with the cash rate.

There are different types of interest rates available, each with their own advantages and disadvantages.

Variable rate

Your interest rate goes up and down in response to changes in the cash rate and other changes by your credit provider.

The advantage of variable rates is that they usually (but not always) go down if the cash rate decreases, which reduces the amount of interest you pay. There are usually no restrictions on making additional repayments if your home loan has a variable interest rate.

The opposite also applies: variable rates usually go up if the cash rate is increased, which means you will pay more interest. The rate may also increase even if the cash rate does not.

Fixed rate

A fixed rate allows you to lock in an interest rate on your loan, typically for 1 to 5 years. This safeguards you against future interest rate rises. It also helps you plan your finances because you know exactly how much you will be repaying.

The disadvantage is you won't benefit from falling interest rates. There may also be restrictions on making additional repayments.

In addition, you may have to pay a large fee for ending the fixed rate period on your loan early, particularly if interest rates have fallen since you fixed your rate. See fees for details.

Partially-fixed rate

A partially-fixed rate loan (also known as a split loan) lets you pay a fixed rate on a portion of your loan and a variable rate on the rest. For example, you may have a $300,000 loan where you pay a fixed rate on $200,000 and a variable rate on $100,000.

You might consider a split loan if you want the security of regular payments on part of your loan, but also want to take advantage of interest rate drops on the other part of your loan. There are usually no restrictions on making additional repayments on the variable part of your loan.

However, fixing part of your loan gives you less flexibility than a fully variable rate loan. If interest rates fall, you will only get the benefit of lower interest on the variable portion of your loan. You may also have to pay a significant break fee if you want to pay out or refinance the fixed rate portion of your loan.

Smart tip

The lowest interest rate may not necessarily be the best value, as fees and charges can add thousands to the cost of a loan. To get a good deal, look at the comparison rate.

Introductory rate

Some credit providers offer low interest rates for the first 1 or 2 years of your loan. These low rates are sometimes called 'honeymoon' rates.

Before taking up this option, find out what the interest rate will be when the 'honeymoon' period ends. Otherwise you could be in for a nasty surprise.

How your loan to value ratio affects your interest rate

Your loan to value ratio (LVR) could affect the interest rate on your mortgage. Your LVR is calculated by dividing the amount of your home loan by the purchase price (or appraised value) of the property.

In general, the higher your LVR, the greater the risk to the lender. Some lenders apply a higher interest rate to loans with an LVR above 80%, so it is important to calculate your LVR and work out what effect it could have on your repayments.

You will also need to pay lender's mortgage insurance if your LVR is higher than 80%.

Case study: Tony and Svetlana split their home loan

Young couple looking at home loan interest ratesAfter 2 years of searching, Tony and Svetlana found their perfect first home. They had read in the papers that interest rates were likely to go up in the next few months, so they decided to split their home loan. On their $500,000 loan, Tony and Svetlana decided to pay a fixed rate of 7% on $350,000 and a variable rate of 7.4% on the remaining $150,000.

Two months after they settled into their new home, interest rates increased by 0.25%, and continued to go up by 0.25% for the next 3 months. This increased their variable interest payments by almost $100 per month. By fixing a portion of their loan they saved over $220 per month.

But had interest rates decreased by 1%, they would be missing out on savings of over $160 a month. Tony and Svetlana were willing to take that risk in exchange for some certainty about their loan repayments.

Comparison rates

Comparison rates can help you work the true cost of a loan by reducing the interest rate and most fees and charges to a single percentage figure. However, cost is not the only thing to consider when you are trying to work out which loan is right for you. See our webpage on comparison rates to find out more. 

How to compare interest rates

You can look on comparison websites to compare interest rates and other features.

Banks, building societies, credit unions and other credit providers usually have information about their home loans on their websites. You may also like to speak directly to these institutions because they often offer discounts on their advertised loans.

If you already have a loan, talk to your credit provider and see if they will make an attractive offer to keep your business.

Work out the effects of different loan choices.

Mortgage calculator

Limits on interest rates and fees

By law you must not be charged more than 48% annually on your home loan (this includes any establishment or other fixed fees).

Fees and charges can add up to thousands of dollars over the life of your home loan, so make sure you know exactly what you're in for - see fees to find out more.

Getting the best deal on interest rates can save you thousands of dollars. Don't forget to factor in fees and charges when you compare rates to get a clear picture of the best value loan.

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Last updated: 22 Nov 2018