When you take out a home loan, you need to repay the principal (the amount borrowed) plus interest. Interest is what a lender charges to let you borrow money. It’s calculated as a percentage of your loan balance and is typically charged at an annual rate. It’s why many interest rates are shown with the letters ‘p.a.’ or per annum.
How is interest calculated on a home loan?
Interest on a home loan is generally calculated on a daily basis on the outstanding balance of the loan. How much interest you end up paying on your loan will depend on a range of factors, including the loan amount, interest rate, loan term, repayment frequency and whether you make any extra repayments or make use of an offset account, if your loan has this option.
Practically, the calculation typically involves multiplying your loan balance by your interest rate and dividing this by 365 days (some lenders divide by 366 days during leap years). This is your daily interest charge. This is then usually multiplied by the number of days in the month to work out your monthly interest amount.
What home loan rates are available?
Home loans can offer a variable or fixed interest rate, or you may be able to split your loan so a portion of your loan has a fixed rate and the rest has a variable rate. With fixed-rate home loans, your interest rate is locked in for a certain period of time (usually between one to five years). With variable-rate home loans, your interest rate can rise or fall throughout your loan term, depending on a number of factors, such as the Reserve Bank’s official cash rate.
Your home loan interest rate can make a big difference to the total amount of interest you pay.
As a hypothetical example, if you have a loan balance of $400,000 at a variable rate of 3.54% p.a., your monthly interest charge will be:
- $400,000 x 0.0354 / 365 = $38.79 interest per day
- $38.79 x 31 days in July = $1,202.49 interest for July month
If you have a loan balance of $400,000 with an interest rate of 2.39% p.a., your interest charge will be:
- $400,000 x 0.0239 / 365 = $26.19 interest per day
- $26.19 x 31 days in July = $811.89 interest for July month
You may be able to make interest-only repayments on your loan for a period of time. However, as you won’t be paying down the principal during this time, this means you’ll generally pay more interest compared to if you were making principal and interest repayments.
Ways to save on home loan interest
If you’re looking to pay less interest on your home loan, there are a few options you can consider, based on your personal needs and circumstances:
1 Make additional repayments
If you are able to make additional repayments above the minimum amount, this will reduce your principal amount and will lower your interest charges. If you have access to a redraw facility, you’ll also be able to access any extra repayments if you need to (although a fee may apply).
2 Use an offset account
If you have a home loan with an offset account, you can use this to pay less interest. An offset account is a transaction account linked to your loan that offsets your home loan balance. In other words, you are only charged interest on the difference between your loan balance and the amount in your offset account. For example, if you have a loan of $400,000 with $50,000 in a linked 100% offset account, you will only pay interest on $350,000 of your balance.
3 Increase your repayment frequency
Some lenders offer you the option of making your repayments monthly, fortnightly or weekly. By switching to a more frequent repayment schedule, you’ll generally be paying less interest. This is because interest is usually calculated daily and the balance that your interest is calculated on will be lower.
If you switch to fortnightly repayments, for example, you may also pay the equivalent of one extra month’s repayment each year. This is because there are 26 fortnights in a year. With less interest, more of your repayments will pay off the principal of your loan, meaning your mortgage will be repaid sooner.
As lenders may take different approaches in calculating loan repayments, it’s a good idea to check how your lender calculates fortnightly repayments to see whether this will be the case for you. For example, some lenders calculate fortnightly repayments by dividing your monthly repayments in half and you pay this amount every two weeks. Other lenders, calculate repayments so that you pay the same amount if you pay fortnightly or monthly.
For more information on this topic, check out our story: Weekly or monthly mortgage repayments: which pays off your mortgage faster?
4 Switch to a lower rate
The New Zealand home loan market is competitive, and with rates changing regularly, what might have been a low rate when you took out the loan could now be out of step with the rest of the market. Lenders may be more likely than you think to offer you discounted rates and favourable terms to keep you around.
Some of the steps you can take to get a better rate on your home loan include:
- Doing your research on the current rates
- Finding out what rates new home buyers are getting
- Not being afraid to ask your lender for a better rate
- Being prepared to switch banks
- Choosing a home loan with a shorter loan term
On this last point: another way to potentially save interest is to switch to a home loan with a shorter loan term. This will reduce your interest in the long term. However, keep in mind that you will need to make higher regular repayments.
Whether you’re considering refinancing your loan or taking out your first home loan, you might like to compare your options with Canstar. We compare hundreds of loans based on both price and features.
To read more about our five-star home loan awards click here, or to compare other mortgage rates hit the button below.
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