Understanding home loan interest rates
Estimated read time: 5 Minutes
When choosing a home loan, it is important to find the right interest rate option to suit your situation. But with so many offers available from so many lenders, finding the right one can be overwhelming.
How do rates get set, what are the different types, why are they different, and what does ‘comparison rate’ mean? Here we provide a guide on interest rates to help you be better prepared for the homebuying process.
How are interest rates decided?
The big influencers on interest rates are:
1. What it costs the lender to offer you a loan
Just like most things that are sold, money comes with a cost for the lending organisation. In Australia, these ‘wholesale’ costs of money – for all lenders – are set by a number of factors, local or global.
Each lender’s funding costs are different. This explains why there are different interest rates from different lenders.
One of the main factors that influence Pepper Money’s decision on changing customer rates is when there’s a change in the rate that banks and professional investors charge to lend each other money. This is called the BBSW (Bank Bill Swap Rate). This extends to other lenders as well, and is part of the reason why interest rates don’t always change when the RBA’s cash rate changes. Other factors can include overall business performance, competitive position in market, and changing economic conditions.
When the cost associated with a customers’ loan changes, the lender will often review the rate that the customer is paying and may increase or decrease the customers’ rate accordingly.
2. The 'risk' to the lender
The other important consideration around how home loan interest rates are set - and another key reason they will vary - is the risk of lending money to a particular customer. Higher risk will often result in a higher rate. The type of things a lender looks for to decide how risky a loan might be are things like the amount of money someone has to put into a property versus how much they are wanting to borrow – called the Loan to Value Ratio (LVR).
LVR gives them a good idea about how much borrowing power a person has and the potential risk of lending to them. The more money a person has saved towards buying a house, the lower the risk – which is why saving a good-sized deposit is important.
Lenders will also look at a person’s ability to repay the loan, by checking key things like previous credit history and current financial situation. This type of overall assessment will be used to decide whether a loan can be offered, and at what interest rate. At Pepper Money we use a form of risk-based pricing. This careful process of personal assessment and pricing is what makes us different to the traditional lenders and allows us to provide loan options to help a wide range of people. Pepper Money, like all lenders, wants to be sure that the loan repayments will be able to be comfortably managed within a person’s circumstances and not create financial hardship.
What are the different types of interest rates?
There are two types of interest rates – fixed and variable.
Fixed Interest Rates
Variable Interest Rates
Tip: Not all rates are advertised by all lenders. For example, a loan provider might advertise a standard variable interest rate, but they might also have rate discounts or alternative loan options, for example, like interest-only for a number of years. So, it’s a good idea to ask them to take you through all the options they have.
How to reduce interest charged on your mortgage?
The primary way to reduce monthly interest charged on your mortgage is to utilise your offset or redraw accounts, as money held in these accounts will reduce the balance that interest is charged on every month. Say you have a $500,000 mortgage balance and have $10,000 in your redraw account. This would mean that your monthly interest is only being calculated on a balance of $490,000. However, not all offset and redraw accounts are equal - while some are free, others come with a monthly fee, so be sure to weigh up the benefits to ensure it's right for you.
What is a comparison rate?
A comparison rate is the true cost of a loan. This means that it includes not just the interest rate, but also any other fees or charges that relate to the loan. While the comparison rate includes fees such as establishment fees and ongoing account keeping fees, it's important to understand that it doesn't include all fees. The aim of the comparison rate is to help you to understand and compare the actual cost of a loan compared to those offered by other lenders.
Where can I get more information?
Remember there are no silly questions. Always ask. Here are some quick tips:
- Ask the specialists. Reach out to a broker in your area who can take you through the process and explain everything along the way or get some advice from a licenced financial or tax adviser.
- Get some insights from your own networks. Ask your family and friends for their experience with the lenders you're looking at. You may not have dealt with them before, but others may have.
- Check for their reviews online. Get a quick overview of how different lenders compare by visiting online comparison sites such as Finder, Canstar or Comparethemarket.
Contributor | Anthony Moir, Treasurer
Anthony joined Pepper Money in February 2021 as Treasurer. With over 25 years of experience in treasury and debt capital markets, he has worked with a diverse range of bank and non-bank lenders. Read more.
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Information provided is factual information only and is not intended to imply any recommendation about any financial product(s) or constitute tax advice. If you require financial or tax advice you should consult a licensed financial or tax adviser.
All applications for credit are subject to credit assessment, eligibility criteria and lending limits. Terms, conditions, fees and charges apply.
The results of the borrowing power calculator are based on information you have provided and is to be used as a guide only. The output of the calculator is subject to the assumptions provided in the calculator (see 'about this calculator') and are subject to change. It does not constitute a quote, pre-qualification, approval for credit or an offer for credit and you should not enter commitments based on it. The interest rates do not reflect true interest rates and the formula used for the purpose of calculating estimated borrowing power is based on the assumption that interest rates remain constant for the chosen loan term. Your borrowing power amount will be different if a full application is submitted and we complete responsible lending assessment. The results in the calculator do not take into account loan setup or establishment fees nor government, statutory or lenders fees, which may be applicable from time to time. Calculator by Widgetworks.
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