Understanding interest on your home loan account will help you understand how your repayments work
When you apply for a mortgage you are borrowing a sum of money that has to be repaid. Interest and fees will be added to the sum or principal in the process of paying it back. All banks and lenders will charge you an interest rate as a percentage per annum, which is calculated according to your outstanding balance and the number of days in the month.
If you have selected a variable interest rate, this can increase or decrease when changes are made to the official cash rate, so it would be a good idea to keep up to date with the Reserve Bank of Australia’s announcements - with the latest cash rate updates.
Why does the interest charged on my home loan increase or decrease some months?
A number of reasons can make this happen;
- The number of days in the month
- Increase or decrease to the cash rate during the month
- Increase or decrease to the outstanding balance during the month
How is your monthly repayment calculated?
This depends on what repayment type you have agreed to
- Principal and interest : These payments will include the monthly interest accrued, any scheduled fees and a portion of your principal.
- Interest-only : For the defined term, these payments will cover the monthly interest accrued plus any scheduled fee.
Most financial institutions allow you to choose to make your repayments on a weekly, fortnightly or monthly basis. The more repayments you make, the faster you can pay off your home loan. Below is the general formula of how the interest is calculated on your home loan.
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How does the cash rate affect me?
The banks are required to notify you as soon as there is a change to the interest rate. Every bank has their own policy on interest rates, but usually the repayment amount will change one month after you receive notice.
Example 1
John Packer has a standard ING Mortgage Simplifier home loan with a competitive variable interest rate of 5.72% p.a with no ongoing monthly or annual fees and a free redraw facility.
Example 2
The same standard home loan with an initial interest rate of 6.22% which decreases to 5.72% per annum part of the way through the month and a repayment of $1950.89 with an additional deposit of $700 on the 14/11 and $400 on the 04/12.
What do the numbers mean?
- Repayments of $1950.89
- Interest charged on the loan at 5.97% p.a. = $1,583.76
- Notification of rate change
- Interest charged on the loan at 5.72% p.a. = $1548.45
- Extra repayments into the mortgage
How is interest calculated on John’s loan?
Here the formula used to calculate the interest of John’s loan during 12 October to 24 December before the interest rate decreased.
Tips to manage your home loan account
- Know the fundamentals about interest and how interest is applied to your home loan account
- Always make your monthly repayment on or before the due date. If you are about the miss a mortgage repayment, ensure that you notify your lender first.
- Set up a direct debit to automatically make payments from your nominated bank account to avoid any late payments. If you do set up a direct debit, then make sure you have enough funds in the account or you could be charged a dishonour fee.
- Always try to pay off more than your minimum repayment and you could take years off your loan - pay more, more often.
- Read and understand the terms and conditions of your home loan account so there is no room for unexpected surprises.
