Today's home loan market is a confusing place. By knowing what interest rates are available to you, you’re in a better position to choose the right loan.
Anyone with a mortgage will have a preoccupation with interest rates, and it’s easy to understand why – it’s the figure that outlines how expensive it is to borrow from a lender or bank. However, according to industry experts, it’s not the be-all-and-end-all of a mortgage. Corporate Affairs spokesperson for brokering company Mortgage Choice Belinda Williamson says it’s about what the loan offers as a whole, not just the percentage advertised.
Here at finder.com.au we want to help consumers better understand the complicated information around products such as home loans so that they can make a more informed decision.
With this in mind, we've written the below to explain the different types of interest rates offered, some the jargon used by banks, how rates are worked out and tips on how to get the best* rate for your needs.
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It's really about finding the loan at the time that's really suited to their needs and circumstances. So the key there is to really do your research to know what your needs are now and also in the future."
Belinda Williamson, Mortgage Choice.
You’ll notice on every home loan product there are two advertised rates.
One is the standard interest rate charged on the home loan and the other is the comparison rate. The comparison rate was introduced by the government in 2003 and takes into consideration fees and charges a borrower is likely to incur from the lender during the life of the loan. It’s mandatory for all lenders to display this rate alongside all advertised interest rates so the true cost of the product they are offering is clear to consumers.
A comparison rate calculates how fees and charges will affect a home loan interest rate and the repayments. All comparison rates are calculated based on a loan of $150,000 taken out for 25 years. The standardisation of comparison rates is supposed to give borrowers an accurate picture of how the different lenders fees and charges are applied to each loan product, but it's important to note that the smaller the loan, the bigger the impact the fees and charges will have on the comparison rate.
This means that the comparison rate isn’t a 100% accurate way of measuring how cost effective a loan is overall. Although it takes into account all the fees and charges the loan will attract from the lender it fails to take into account outside fees and charges such as: government fees and charges, legal disbursements and valuations done outside any products that may include them.
It’s an indicative guide only and should not be taken as gospel when calculating the true cost of your loan, this is why it is always important to compare home loan options available in the market.
How do the banks set their lending rates?
On the first Tuesday of each month, the Reserve Bank of Australia (RBA) meets to decide whether to adjust the official cash rate target.
The cash rate is an interest rate charged between banks to borrow or lend money on an overnight basis. The RBA then decides if the official cash rate should remain at the same rate, increase or decrease in order to maintain inflation between 2-3% in the medium term. Inflation is kept at this rate to ensure the Australian economy continues to grow. When the RBA adjusts the cash rate target, the effect filters down through the rest of the economy.
Lenders calculate their own interest rates based on the official cash rate and other factors such as the costs associated with raising funds and current market conditions. This means even if the RBA decides to lower the cash rate by 0.25%, lenders can choose to pass on as much as or as little as they like in order to protect their bottom line. After the RBA decides on the rate lenders will begin the scramble to announce their response, with lenders like ANZ now stepping away from the crowd and announcing their rate review a week after the RBA.
A variable rate can rise and fall to reflect the movements in the market’s lending rates.
Essentially when the RBA adjusts the cash rate, it’s sending a signal to the market that the cost of borrowing funds has changed (either up or down). Lenders take this cue from the RBA and will adjust their own lending rates based on a number of factors. If you have a variable rate loan, your repayments will rise and fall based on these adjustments on the markets.
If your lender lifts their standard variable rate, your repayments will rise, the opposite also applies.
Variable rate home loans tend to come with a variety of additional features. The extra goodies offered with the variable rate loans allow borrowers to redraw any additional repayments, offset their mortgage against their savings and refinance with another lender without penalty if they think they can get a better deal.
What are the pros and cons of a variable rate loan?
- Possible fall in rate: The main financial benefit to having a variable rate home loan is that if the cash rate falls then your payments may also decrease.
- Extras: Variable rate loans tend to come with value adding features such as an offset account that can help save on interest, and redraw facilities for when you need to access any additional extra funds you have paid into the loan.
- Possible rise in rate: On the opposite side of your payments potentially falling if the cash rate does, if there are increases in the cash rate, then this can also be passed on which could increase your repayments.
What kinds of borrowers is a variable rate loan suited to?
- Those who are happy to have their repayments change with the ebb and flow of the market and the changes to the cash rate.
- Anyone who wants to have extra features on their loan that help with paying it off sooner.
- People who prefer to have the flexibility to change their loan terms rather than being fixed into a term of "X" amount of years.
- Bargain-hunter borrowers who don’t mind chasing a deal from one lender to the next.
A fixed rate loan locks in a set interest rate at the beginning of a loan term for an agreed time frame, usually a period of one to five years. During this period, your repayment will not change. Once the fixed rate period ends your loan will either revert to a standard variable rate loan or you will be given an opportunity to sign up for another fixed rate period.
What are the pros and cons of a fixed rate loan?
- Cost stability: With the rate being fixed for whatever period you choose, you can then budget for all your funds knowing exactly how much your repayments will be.
- Less stress at RBA time: When you have fixed your interest rate you won’t have to be as concerned about any changes in the overall cash rate, at least not until your fixed period expires.
- Rate lock option: There is often an option to lock in the fixed rate that is advertised when you apply for the loan, rather than worrying that the rate will change between the time you apply and the settlement of your loan.
- No chance of lower payments: The major downside to fixing an interest rate on a home loan is that if rates fall, this will not be passed onto you as your rate is fixed for a given period of time.
- No extra features: With a fixed rate loan a lot of the features that come with a variable rate loan may not be available, or may incur a fee if they are available.
- Break costs: There are fees that come with "breaking" the fixed period of a loan if you want to pay out the loan early, you wish to refinance or switch to another lender. These fees can sometimes negate any possible savings you may think you will make if you were looking to refinance to get a better deal.
Who is a fixed rate loan suited to?
- Budget-savvy borrowers: These are borrowers who would prefer to know exactly what their repayments are so that they can organise the rest of their budget every week, month or year.
- Low-income borrowers: These borrowers would prefer to have the peace of mind of there not being any chance of their repayments changing as they have such a tight budget as it is.
- Financial-savvy borrowers: These are people that have researched the market and can see that there is a trend or high possibility that rates will rise in the near future so want to lock in a current rate.
- Record low rates: This is one of the most common reasons borrowers choose to fix their rates. They may see that the current rates in the market are historically low, and as with the above, they don't believe this will happen again for some time. For instance during the Global Financial Crisis, many borrowers locked into a fixed rate of interest when the cash rate dropped from almost 7% to approximately 3%.
When considering a fixed rate loan it really comes down to whether or not borrowers think that current rates are a good deal and whether they think rates will increase in months and years to come.
An introductory rate is an interest rate discount offered by lenders on a loan for a specific period of time when you initially take it out. These are also sometimes known as honeymoon rate loans and usually last a year. The discount they offer can be as much as a whole percentage point lower than the standard advertised rate.
What are the pros and cons of an introductory rate loan?
- Discount: The main advantage of this loan is that it has a discounted rate. A lower rate means lower repayments in the first stage of your loan.
- Variable rate: Having a variable rate also allows you to have access to all the extra features that come with a variable rate loan such as offset, redraw and extra repayments.
- High exit fees: Introductory rates usually are accompanied by high exit fees if you wish to refinance at the end of your introductory period.
- Higher revert interest rates: The interest rates that the loan reverts to after the introductory period are often less competitive than the standard variable rate or other rates the lender has in the market. Make sure to research these before choosing an introductory rate loan.
Who is an introductory rate loan suited to?
- Borrowers who are building: If you’re building a home you’ll be paying for construction costs and an introductory rate loan will allow you to spend less on your repayments and more on your home.
- Investor renovating: Renovating an investment property means you won’t be able to have tenants in your property, which prevents incoming rent to help you with repayments. In this case, an introductory rate loan could help you to minimise the costs associated with this.
- First home buyers: They are often attracted to introductory rate loans due to the expensive nature of the first years of homeownership.
A way of benefiting from both rate types is to split your home loan into more than one portion. This means one part of your loan will benefit from lower rates by being under a variable rate, while the other fixed portion will hedge your loan against any rise in interest rates.
Many lenders now allow you to do this and even allow you to split your loan more than once so you can have full control over how your repayments are worked out.
What are the pros and cons of a split loan?
- Variable rate extra features: When you split your loan and have a portion under a variable rate, this gives access to all the great extra features offered with variable rate loans but not fixed rate ones. Some features include a 100% offset account, fee free extra repayments and redraw facilities.
- Fluctuating rates: With a split rate you can still take advantage of any decreases in the standard rate but without having to redo your whole budget as you also have a portion fixed that will not change.
- Higher set-up fees: Split loans can come with higher set-up or establishment fees as they are slightly more complicated to set-up than a standard loan.
A little knowledge can go a long way when it comes to saving money with your home loan. You don’t need to commit to features like an offset account or extra repayments (although these do help) to save, you can start with something simple: a low-interest rate.
Below are some useful hacks to help you pay less interest on your loan so you can own your home sooner.
Prepare your finances
What a lot of people don’t realise is that almost everything you do financially whether you have a home loan, credit card or personal loan is recorded on something called a credit file or credit history. This file records any applications for financial products you have done in the past, unpaid bills or any defaults you may have had.
A credit history check is one of the most vital things lenders use to assess whether to offer you a loan, they want to make sure that you can make your repayments in a timely manner and that you don’t have any recorded defaults.
The steps you take to manage your credit history when you first start borrowing money with a credit card or personal loan or even just by paying your bills on time is the tried and tested answer lenders offer when denying any loan applications.
Make sure that you make any loan, credit card or other bill repayments on time and are actively paying down any debt you have. Lenders like to see that your finances are in good order. A bad credit history generally means you’re more of a risk to the lender, which could result in a higher interest rate or a flat out denial of borrowed funds.
To put yourself in the best position to negotiate with your lender, you can order a copy of your credit history to see where you stand. You’ll also be able to see if there are any incorrect listings on your credit history that you can then dispute before applying.
Not all lenders are made equal, so you need to shop around to see where the deals are and who is offering a loan that suits your specific needs. Comparing interest rates will increase the chances of you getting the best* interest rate on offer and don’t be afraid to go beyond the major banks.
In our blue comparison tables such as the one displayed on this page, you can click on ‘Interest Rate (p.a.)’ to help you sort the rates in ascending order. You can find out what the lowest rate is with just a few clicks! Or if you are more concerned with upfront costs you can filter by clicking on the ‘Application fee’ header and see who has the highest or lowest application fees.
During your loan
The type of loan you get also has an impact too. Try to aim for a low loan-to-value ratio as this often has a lower interest rate, which means you’ll need as big of a deposit as possible.
You’ll also need to take into consideration future economic conditions such as the official cash rate; if interest rates are about to go up then you may want to fix your interest rate to ensure it stays low. Similarly, if it goes down then you’d want your rate be variable to go down with it.
Ask for a lower rate
Before you sign on the dotted line, try to use the leverage of any research you have done to lower the interest rate a bit more. This is why step two is so important, you need to know what’s being offered in the market to be able to negotiate a rate that is competitive.
Even if you’re currently paying off a home loan, you can compare loans to help you with your decisions around refinancing. Asking your lender to reduce your home loan interest rate to be on par with the rest of industry might be scary, but the thousands of dollars you could save are worth it.
While all of these hacks can help you find a competitive interest rate, the reality is that most of these can only be used to their full potential if you start with a good credit standing. Staying on top your finances and regularly maintaining your accounts will put you in the best position you can be in before you approach any lenders and they will all be fighting for your business.