Understanding Interest Rates
How interest rates work, what affects them, and how to choose between fixed and variable rates.
Interest rates are one of the most important factors in your home loan. They determine how much you'll pay over the life of your loan and can make a significant difference to your monthly repayments. Understanding how they work helps you make smarter borrowing decisions.
What is an Interest Rate?
An interest rate is the cost of borrowing money, expressed as a percentage of the loan amount. When you take out a home loan, the lender charges interest on the money you borrow. This is how they make money from lending.
Example Calculation
Loan Amount
$500,000
Interest Rate
6.0% p.a.
Annual Interest
$30,000
At 6% p.a., a $500,000 loan costs approximately $30,000 in interest per year (simplified calculation)
Fixed vs Variable Rates
The two main types of interest rates you'll encounter are fixed and variable. Each has its own advantages and suits different borrowers.
Fixed Rate
Your interest rate stays the same for a set period (usually 1-5 years).
Certainty - know your exact repayments
Protection if rates rise
Easier budgeting
Break costs if you refinance early
Miss out if rates fall
Less flexibility (limited extra repayments)
Variable Rate
Your interest rate can change at any time based on market conditions.
Benefit when rates fall
More features (offset, redraw)
No break costs to refinance
Repayments can increase
Harder to budget long-term
Uncertainty about future costs
Split Loans: Best of Both Worlds?
A split loan divides your mortgage into fixed and variable portions. For example, you might fix 60% of your loan for certainty while keeping 40% variable for flexibility.
Example Split
$500,000 loan = $300,000 fixed + $200,000 variable
Benefits
Partial protection + offset account on variable portion
What Affects Interest Rates?
Reserve Bank Cash Rate
The RBA sets the official cash rate, which influences what banks charge borrowers. When the cash rate rises, your variable rate usually follows.
Your Loan-to-Value Ratio (LVR)
Borrowing more than 80% of your property value usually means higher rates. Lower LVR = lower risk for lenders = better rates.
Loan Type
Investment loans typically have higher rates than owner-occupied loans. Interest-only loans often cost more than principal & interest.
Competition
Lenders compete for business, which can work in your favor. Online lenders and smaller banks often offer more competitive rates.
Your Credit History
A strong credit score can help you negotiate better rates. Defaults or late payments may result in higher rates.
Understanding Comparison Rates
What is a Comparison Rate?
The comparison rate includes the interest rate plus most fees and charges, giving you a more accurate picture of the true cost of a loan. Always compare loans using the comparison rate, not just the advertised rate.
Advertised Rate
5.99%
Comparison Rate
6.45%
The difference shows the impact of fees. A loan with a low rate but high fees may cost more overall.