You’ll usually plan for mortgage repayments in your household budget. If they increase, it may put a strain on your finances. On the other hand, if they are reduced, you can plan how to use the extra money for another purpose. You might ask, why does the mortgage repayment amount fluctuate? It fluctuates because, from time to time, banks change the rate of interest that they charge you depending on overall market trends.
Your mortgage repayments are made up of two components. The first part is a portion of the principal, and the other is the interest charged on that principal amount. To work out the monthly repayment, your lender will divide the total amount you’ll pay over the life of your loan by the number of months in your loan term. You’ll end up paying almost an equal amount each month.
If you choose a variable rate home loan, then you may occasionally be told that your monthly repayment has gone up or down as the interest rate has changed. If you choose a fixed rate home loan, on the other hand, you wouldn't have to worry that it will increase until the fixed-rate period expires. But you may lose out on savings if the variable rate drops below what you are paying.
How does the interest rate affect me?
The interest rate affects the total amount you’ll repay over the life of your home loan. Any fluctuation in the interest rate changes the total amount your home loan will cost you. You should consider this when you’re borrowing, especially if you’re thinking of taking out a variable rate home loan. It's a good idea to think about how you will manage repayments if the interest rate increases. You could consider saving some money to meet this contingency if it arises or making extra mortgage repayments whenever you have funds available.
A home loan calculator is a very convenient way to see how the interest rate affects mortgage repayments, and it can help you see how any changes will affect the repayments.
Let's assume that you borrow $500,000 at 3 per cent interest for ten years. The total interest you’ll pay works out to over $79,000. Your monthly repayment, which includes both principal and interest, will be a little over $4,800.
If the interest rate increases to 4 per cent, you would end up paying more than $107,000 in interest over ten years, and your monthly repayment would be over $5,000. On the other hand, if the interest rate reduces to 2 per cent, your total interest cost goes down to about $52,000, and your monthly repayment is about $4,600 only.
These examples demonstrate that your total interest cost is significant and how a change in interest impacts this amount. It also illustrates that you need to pay attention to changes in the interest rate and its impact on your finances.
Why do lenders change interest rates?
Lenders borrow funds from other financial institutions at an interest rate termed the cash rate and set by the Reserve Bank of Australia (RBA). Each month, except for January, the RBA decides to increase, decrease or hold the cash rate based on various economic factors. When the cash rate changes, your lender may change your home loan’s interest rate, especially if it’s a variable rate home loan.
A lender isn’t obligated to change the interest rate on its products every time the cash rate fluctuates. Still, it’s the general expectation and what generally happens. Lenders can also choose to raise or lower the interest rate outside any cash rate changes based on their business objectives.