When you’ve found the perfect home to purchase, or the perfect block of land to build on and it’s time to organise a home loan, your mortgage broker will start talking to you about interest rates and which home loan gives you the best rate. If you’ve never held a mortgage before, it might initially feel confusing to be talking about rates and percentages, so we’ve got a quick break down of interest rates, what they are, and how they impact your mortgage over time.
The Reserve Bank of Australia
The Reserve Bank of Australia (RBA) is Australia’s central bank, and it conducts the nation’s monetary policy and issues its currency. It also sets something called the ‘cash’ interest rate, which is reviewed each month. The cash rate is the overnight money market interest rate. At the monthly review, the RBA will decide to either increase, decrease or put interest rates on hold, which in turn affects how much your mortgage repayments will be.
Credit providers are financial institutions that provide credit to individuals and businesses. Often people know these providers as the major banks, but there are credit unions who also offer competitive interest rates. Credit providers have the ability to set their own interest rates, and can increase or decrease their rates in line with the RBA’s cash rate changes. It’s worth noting that while the RBA cash rate may remain unchanged, credit providers can adjust their rate when they deem it appropriate to do so.
A variable rate means your rate will fluctuate in response to the cash rate and other changes that have been made by your credit provider. The advantage to having a mortgage with a variable rate is that the rate will often (but not always) decrease if the RBA’s cash rate decreases, which will then reduce the amount of interest you pay. Another benefit to having a variable rate is that you can make additional payments to your home loan, meaning the loan can be paid off sooner. However, remember that a variable interest rate will also increase if the cash rate increases (and can also increase even if the cash rate does not). It’s an interest rate that will change frequently throughout the life of the loan, so you should ensure your finances allow for these changes, particularly the increases.
Having a fixed rate for your mortgage means you can lock in an interest rate, often for one to five years of your home loan. This means that while the rate is locked in, your repayments won’t change during that time. You’ll be able to plan your finances accordingly because you’ll know exactly how much your repayments will be. This is beneficial during times of national or worldwide financial uncertainty or crisis, when cash rates may increase significantly; your rate will be safeguarded against these changes. On the flip side though, a fixed rate means your repayments won’t decrease if interest rates go down, so you may find yourself locked in to a fixed rate that’s much higher than the cash and variable rate. There may also be restrictions on making additional loan repayments if you have a fixed rate, and your credit provider may impose a fee for ending the fixed rate period.
This type of interest rate offers the best of both worlds. You can pay a fixed rate on part of your loan, and a variable rate on the rest. This allows you to take advantage of interest rate drops on the variable part of your mortgage, and the fixed rate partially protects you from interest rate increases. Often you can still make additional repayments to your loan, helping you pay it off faster.
If you’re ready to build or purchase a home this year, doing a little research to properly understand interest rates and how they will affect you as a property owner will help you have a clearer idea of how to plan your finances accordingly. For more information about building your own home, visit the Hotondo Homes website today.
Hotondo Homes is not a registered financial advisory and we recommend you speak to your financial advisor or mortgage broker to receive expert advice before you enter into a loan contract or real estate contract of sale.