How home loan interest rates work

4 min read | 29 July 2021 

A home loan interest rate is used to calculate what you’re charged to take out a home loan. But the magic number you end up with and the type of rate you choose is influenced by a bunch of factors. Let’s strip it back to the fundamentals in this interest rate explainer. 

A home loan interest rate is a percentage of the total amount of your outstanding loan balance. It’s expressed as an annual rate (p.a. stands for ‘per annum’).

The interest is usually calculated daily on whatever you have left to pay off on the loan.

($ Outstanding loan amount) x (% Interest rate p.a.) ÷ 365 (or 366 days in a leap year!) = Interest charges

Every time you make a minimum loan repayment, you’re paying interest. In most cases, you repay a portion of the borrowed amount – known as the principal – and a portion of the interest charges.

Some borrowers pay the interest charges only for a period of time, and this is known as an interest-only loan.

There are two main home loan rate types. You might have one or a combo of interest rate types throughout the life of your home loan.

The rate could change at any time. The lender might change it, or you might ask them to negotiate a deal. 

TOP TIP! – it’s always worth an ask when it comes to your current rate

The rate is set to an unchanging number for a 1- to 5-year term. Handy if you need repayment certainty for a while.

TOP TIP! – some loan features may not be available, like redraws and early repayments, which you may be penalised for in the form of fees.

The loan is a mix of variable and fixed rates. Some people opt for a 50:50 split, others may weight it differently. You’re hedging your bets on the rate going up or down.

TOP TIP! – great for the security of fixed and flexibility of variable 

Do your sums carefully when looking for a loan or negotiating a deal with your current lender. The difference in repayments between 2.5% p.a. and 2.75% p.a. is significant.

It could save you thousands and years off your loan.

Check Athena’s home loan calculator

You might see these rates in a lender’s advertising or inside the home loan terms and conditions. The devil’s in the detail.

A short-term type of variable home loan rate. 

You’re basically on a low-ish rate then you go on to something higher.

The intro rate goes by a few different names – like ‘discount rate’, ‘discount variable rate’ (DVR) or ‘honeymoon rate’.

They’re often targeted at first home buyers or low-income earners to ‘help out’ in the early days of a home loan. But they can go quite high afterwards. 

Before you apply: Know what happens when the honeymoon is over and perhaps be ready to refinance before your rate switches over?

The lender’s advertised variable rate for a particular loan product. 

Some lenders have a SVR or equivalent, some don’t. There are no industry-wide criteria.

The SVR goes by a few different names – like ‘base rate’, ‘headline rate’, ‘benchmark rate’ or ‘reference rate’.

Good to know:

• Some lenders use a SVR for advertising purposes – to attract new customers then offer (hidden) discounts or rate hikes depending on the borrower’s profile.

• Some lenders use a SVR for legal purposes – for example when a fixed rate term is up and the loan reverts to the lender’s SVR equivalent, it must be disclosed up front in the customer’s contract.

• Some lenders use the SVR for a bit of both – case in point, introductory rates as above.

Before you apply: Ask to have all the rates and related small print explained.

Helps you compare lenders and loan products.

You’ll see it next to the advertised rate on variable and fixed rate home loans.

The comparison rate is expressed as an average, taking into consideration things like the advertised rate, application fees and ongoing costs. It’s there to help you understand the truer costs involved when paying for a home loan. 

All lenders in Australia must follow the same formula – i.e. it’s calculated based on borrowers with a loan of $150,000 which they pay off over 25 years by making principal and interest repayments.

Before you apply: Take 5 minutes to compare the comparison rates of your top three lenders.

Where fixed rates change at the end of your term, typically moving you to a variable rate home loan, variable rates can change at any time. Lenders are obliged to tell you well in advance of any rate changes.

Variable rate changes happen due to many factors, including:

1. The RBA makes a change to the official cash rate (if they drop rates, so might your lender).

2. The cost of money in the wholesale money markets goes up or down (lenders, including the big four, borrow money too)

3. You pick up the phone and try negotiating a new deal or switch lenders for a better rate.

We haven’t seen it in Australia over the last couple of decades. But if RBA cash rates ever hit zero or negative and these are passed on to borrowers, the theory is that economic movement could get a nice, big kick up the bum – growing jobs, trade and inflation. (A true borrower’s market should it ever occur. Less sparkly for savers yet to take a step up the property ladder.)

Ideally, you want a great interest rate that stays great with a lender that’s on your side. To learn more about Athena, you can check Athena’s current home loan interest rates or look at our home loan hacks – the redraw hack in particular is handy for reducing interest.