Interest is the money a lender charges a home loan recipient for borrowing money. It’s calculated daily as a percentage of the amount of money that is loaned and is expressed as a percentage number per annum (p.a.). Think of it as a fee you’re charged for borrowing money. The lower the interest rate, the less you have to pay for your home loan mortgage. For this reason, comparing home loan interest rates is vitally important if you want to find the lowest interest rate loan on the market in Australia. That’s why comparing home loans with Savvy to find the best mortgage rate can potentially save you thousands.
How does the Reserve Bank affect home loan interest rates?
The Reserve Bank of Australia (RBA) sets the daily cash interest rate, which is the base interest rate the banks use (both nationally and internationally) to loan money to each other. As of early 2022, this cash rate stands at 0.10%, which is a record low in Australia and has led to current mortgage rates starting just above 1.5%.
The banks and lenders base their own home loan mortgage rates on the Reserve Bank cash rate and tend to increase or decrease their current mortgage rates in line with changes announced by the RBA after their meeting on the first Tuesday of every month (except January). A very low RBA cash interest rate leads to low interest rates for home loans, car loans, personal loans and more. It’s good for borrowers, but not for savers.
How is interest on a home loan calculated?
Interest on a home loan is calculated based on the outstanding balance of your loan at the end of each day. To find out how much interest you are paying per day, multiple your loan sum by your interest rate (expressed as a decimal number) and divide this by 365 to get your daily interest rate.
For example, say you have a loan of $450,000 and your interest rate is 2.5%. Your daily interest is calculated as:
($450,000 x 0.025) ÷ 365 = $30.82 per day interest
This daily interest figure is multiplied by the number of days in the month, and this is the monthly interest you’ll pay. As your outstanding principal decreases, so too will the cost of interest on your home loan. You can use Savvy’s handy home loan repayment calculator to tell you how much interest you’ll pay on any loan sum over a set loan period.
What is the difference between a base interest rate and a comparison rate?
Under the National Consumer Credit Protection Act 2009 (commonly known as the National Credit Act), all lenders are obliged to display the interest rate they charge for lending money (be it for a home loan, a car loan or a personal loan) but also a comparison rate alongside it. This comparison rate must include the fees and charges which form part of that loan’s terms and conditions, so that consumers are able to make valid comparisons between different loans.
The fees and charges that are included in the comparison rate include loan establishment fees, on-going account-keeping or administration fees and annual account charges. However, a loan comparison rate does not include government fees or charges, or other charges such as loan exit fees which a borrower may choose to pay if they want to refinance and break a fixed term loan agreement.
How is the comparison rate calculated?
All home loan comparison rates are based on a $150,000 loan taken out over 25 years, so that borrowers can see how the fees and charges attached to the loan increase the base interest rate. For example, the advertised base interest rate may be 1.89% p.a., but the comparison rate is 2.5% p.a. This means when the lender’s fees and charges have been added on to the basic interest rate charged for the loan, you will actually pay the equivalent of 2.5% p.a., not 1.89% p.a., for that particular loan. That’s why the comparison rate is the more important number to use when comparing mortgage interest rates, or any home loan rate for that matter.