How to calculate home loan interest

Comparing home loan options and trying to figure out how to calculate home loan interest? Savvy is here to help!

How to calculate home loan interest

Calculating the projected cost of your home loan’s interest is a necessary step when comparing your home loan options. Here you can find out how to calculate your home loan’s interest, how to reduce your interest payments, and what factors impact your home loan interest rates.

How do I calculate the interest on my home loan?

The amount of interest you pay on your home loan will be impacted by many factors including: your loan amount, loan interest rate, loan duration, frequency of repayments, and whether or not you opt to make additional repayments. The interest on your home loan is best calculated on a daily basis on your loan’s remaining balance.  

In order to calculate your home loan’s interest, you must multiply your loan balance by your interest rate as a decimal (e.g., 2.5%=0.025) and divide this figure by 365 days (or 366 days for a leap year). This amount will be your daily interest figure, which then needs to be multiplied by the number of days in a given month to calculate your monthly interest payable.  

What economic factors effect home loan interest rates?

Your home loan interest rate is bound to be impacted by a range of economic factors. These economic factors can include but are not limited to the following:

  • The official cash rate handed down by the Reserve Bank of Australia (RBA). The RBA will release their official cash rates at the beginning of each month. These official cash rates play a large role in determining the interest rates provided to you by lenders.
 
  • The supply of funds which are available to lenders and demand for funds from borrowers themselves. If the demand for mortgage funds becomes greater than that of the funds available, banks will likely have to raise interest rates. Oppositely, if the housing market is down and slow, banks will have more money to lend and borrowers will be able to obtain home loans with lower interest rates and special discounts.
 
  • Consumer confidence. Consumer confidence is a strong indicator of overall state of Australia’s economy. A high level of consumer confidence can build belief from the RBA in the Australian economy and result in a gradual rise in interest rates which will likely impact your home loan interest rates.

How does the Reserve Bank of Australia impact my home loan interest rate?

The RBA is responsible for setting Australia’s official cash rates (or interest rates) which are charged on overnight loans to banks, your primary lenders. These interest rates impact all Australians as they effect the rates of financial products, including your home loan and its interest rate. The primary goal of the RBA in setting official interest rates, is to ensure a stable Australian currency, strong employment, and a strong economic future, while making sure inflation stays at a low and stable level. While lenders base their interest rates on several factors, the most important one is the RBA’s official interest rate.

Why do interest rates go up?

Interest rates can go up due to several factors. Interest rates may rise if:

  • Australia’s trading partners are performing strongly and the demand for and cost of raw materials is increasing. This will lead to significant growth for the Australian economy and drive interest rates higher.
 
  • The economy is strong, and inflation is increasing. In this instance, the RBA may increase interest rates to prevent an ‘overheating’ market. This is because a cycle of boom and bust can often lead to recession.
 
  • The housing market becomes too expensive. If house prices are too high, the RBA may opt to increase interest rates to encourage people to borrow less money and ultimately lower the cost of Australian homes.

Why do interest rates go down?

On the contrary, the interest rates may also go down if:

  • Demand for Australia’s natural resources and commodity prices fall. This is due to the potential for slower economic growth in the future which may require the RBA to set lower interest rates and lenders will follow suit.
  • The RBA sees that it’s necessary to lower interest rates to drive economic activity in Australia. Lower interest rates encourage people to spend now as opposed to later. It may also encourage businesses to borrow now and increase spending on investments such as capital assets.

How do I reduce the amount of interest I pay on my home loan?

There are numerous ways you can ensure you are paying less interest on your home loan including:

  • Using an offset account – By using an offset account, the goal is to pay less interest over the term of your loan. An offset account is simply a transaction account attached to your home loan which offsets your outstanding home loan balance. The primary benefit of using an offset account is that the interest you are charged only applies to the sum of the difference between your outstanding home loan balance and the money in your offset account. E.g. If you were to have a loan balance of $500,000 and $100,000 in an offset account, you will only be charged interest on $400,000 of your home loan’s balance.
 
  • Make extra repayments on your home loan – By making additional home loan repayments, in excess of the loan’s minimum repayment amount, you will continually be reducing your home loan’s principal amount and lower the total interest payable over the loan’s term.
 
  • Reduce the duration of your home loan’s term – By choosing or switching to a home loan with a shorter term, you will ultimately be reducing the overall interest you pay on your home loan. It is important to keep in mind that with a shorter-term loan, your repayments will be significantly higher which may not suit your financial situation.
 
  • Increase the frequency of your repayments – Most lenders will give you the choice of monthly, fortnightly, or weekly repayments. If you decide to opt for a repayment schedule with more regularity, you will ensure you are saving on interest as you continue to pay down the loan’s principal amount.
 
  • Change to a lower interest rate – Your current lender will go to great lengths to keep your business. Always be vigilant and keep your eyes on the market for better rates and deals. If you can prove to your lender that competitors are offering better interest rate deals, you may be offered discounted rates and better loan terms to prevent you from refinancing your home loan with a different lender. Be willing to speak to your lender and see what they can do for you!

Top tips regarding home loan interest rates

To ensure you’re calculating your home’s interest correctly and getting the best interest option for you, follow Savvy’s top tips.

If you’re concerned about interest rates rising, switch to a fixed rate

While a standard variable rate will increase and decrease with interest rates decided upon by the RBA, a fixed rate will allow you to know precisely what your repayments will be, and you will avoid the frustration of an increase in interest charges. However, it is important to note that a change to a fixed interest rate may also come at the cost of some loan features and break fees.

Paying too much interest? Change your loan’s terms

If you find that you are paying more interest than you would like on your home loan, consider changing some of your home loan’s terms. This could be adding an offset account, increasing your repayment frequency or asking you lender for a lower interest All thesechanges can significantly reduce the interest you pay over the duration of your home loan.

Use a mortgage calculator online

If you find it difficult to calculate your home loan interest using the formulas and explainers featured, you can use an online mortgage calculator to help you through the process.

Frequently asked questions about calculating your home’s interest

Do you have further queries regarding the process of calculating your home’s interest? Here we try to answer some of the most common questions.

Why do banks sometimes not pass on rate cuts when the RBA announces a cut in cash rates?

While many banks will opt to pass on rate cuts, many will often not. When assessing whether or not to pass on rate cuts, banks will need to weigh up the overall performance of the housing market, their own performance as a business and what their rivals are doing to see what’s best going forward. If it’s in the banks best interest to not pass on cuts, then they will do exactly that but at a cost to the borrower.  

Should I choose for monthly, fortnightly, or weekly repayments?

The best repayment option for you depends on your situation. It is important to assess things like your pay cycle, ability to meet minimum repayments and your long-term goals with your home loan. If you can afford to make high-frequency weekly repayments, then that can be handy in lowering the interest you will pay over the term of your loan. If you find that you will not be able to make frequent payments and are on a stricter budget with your home loan, monthly repayments may best suit your situation. 

I am paying more interest on my home loan than I expected, what can I do?

If your interest payments are more then you expected and you wish to change them, you can speak to your lender directly and see if they are willing to offer you a discount or reduced rate. Lenders will go to great lengths to maintain your business, so contact your lender right away!  

If I purchase an investment property, will I be charged a different interest rate?

Investment properties will usually incur higher interest rates than that of standard owner-occupier properties. This is because lenders consider it as taking on greater risk. Investment property interest rates are typically 0.5-0.75% greater than that of traditional home loan interest rates.  

At what rate are home loan interest rates typically charged?

Home loan interest rates are usually charged at an annual rate. When browsing and comparing home loan options, you will usually see a percentage followed by a ‘p.a.’, standing for ‘per annum’.  

Does a lower interest rate mean it is the better home loan option?

Not necessarily. When weighing up your home loan options, it is also important to consider the array of fees and charges that come with it. While some home loans will offer low interest rates, it may come at the cost of extra fees and charges which will add up over the duration of your home loan. Do your research, do it thoroughly and make sure to calculate the overall cost of home loans, inclusive of fees and charges.