Home loan repayment methods

Home loan repayment methods

If only home loans came with an instruction manual explaining the difference between all the facts and figures. Understanding your repayments, interest, fees and charges can be overwhelming and it’s easy to overlook, or not understand certain aspects.

When it comes to making repayments you can simplify the process by understanding you have two options for repayment instalments. You can either make repayments on a ‘principal and interest’ basis or pay by ‘interest-only’ instalments.

Want to know the difference? Use the RateCity’s home loan interest calculator to calculate both options and by doing so, you’ll be able to estimate your repayments and determine the total amount of interest payable over the life of the loan.

So what’s the main difference, you ask?

Principal and interest loans

Making principal and interest (P&I) repayments will reduce the principal, as well as the amount of additional mortgage interest you’ll pay over the term of the home loan. That said, if you select a P&I option, your repayments will be higher than if you make interest-only payments.

A P&I loan is the most common variety of home loan in Australia, and RateCity’s home loan calculator lets you compare the costs of home loans in this category.

Choosing a P&I option can be a smart choice if you intend living in a property long-term. By paying off the capital, you also increase your equity stake in the home, and help speed up the path to outright ownership. Moreover, a P&I strategy simultaneously helps trim additional interest payments. Choosing a low interest home loan can also help cut the additional interest impost.

Interest-only loans

With an interest-only loan, you only pay the mortgage interest set by the lender, which means you don’t pay off any of the capital. Interest-only loans, therefore often involve selling a property to repay the principal.

Interest-only loans are typically aimed at investors. In reality, an interest-only home loan, enables investors to hang onto a rental home, which over the course of the loan, should generate rental income and possibly some capital gains. Furthermore, the interest component of the loan is tax deductible.

Typically investors, who believe they own a quality, well-located property, with solid long-term growth prospects, choose interest-only home loans.

To estimate the overall costs of your home loan, use RateCity’s home loan calculator and home loan comparison tool to compare some of Australia’s best home loans

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Learn more about home loans

How can I calculate interest on my home loan?

You can calculate the total interest you will pay over the life of your loan by using a mortgage calculator. The calculator will estimate your repayments based on the amount you want to borrow, the interest rate, the length of your loan, whether you are an owner-occupier or an investor and whether you plan to pay ‘principal and interest’ or ‘interest-only’.

If you are buying a new home, the calculator will also help you work out how much you’ll need to pay in stamp duty and other related costs.

What is an interest-only loan? How do I work out interest-only loan repayments?

An ‘interest-only’ loan is a loan where the borrower is only required to pay back the interest on the loan. Typically, banks will only let lenders do this for a fixed period of time – often five years – however some lenders will be happy to extend this.

Interest-only loans are popular with investors who aren’t keen on putting a lot of capital into their investment property. It is also a handy feature for people who need to reduce their mortgage repayments for a short period of time while they are travelling overseas, or taking time off to look after a new family member, for example.

While moving on to interest-only will make your monthly repayments cheaper, ultimately, you will end up paying your bank thousands of dollars extra in interest to make up for the time where you weren’t paying off the principal.

What is 'principal and interest'?

‘Principal and interest’ loans are the most common type of home loans on the market. The principal part of the loan is the initial sum lent to the customer and the interest is the money paid on top of this, at the agreed interest rate, until the end of the loan.

By reducing the principal amount, the total of interest charged will also become smaller until eventually the debt is paid off in full.

What are extra repayments?

Additional payments to your home loan above the minimum monthly instalments, which can help to reduce the loan’s term and remaining payable interest.

Interest Rate

Your current home loan interest rate. To accurately calculate how much you could save, an accurate interest figure is required. If you are not certain, check your bank statement or log into your mortgage account.

How can I pay off my home loan faster?

The quickest way to pay off your home loan is to make regular extra contributions in addition to your monthly repayments to pay down the principal as fast as possible. This in turn reduces the amount of interest paid overall and shortens the length of the loan.

Another option may be to increase the frequency of your payments to fortnightly or weekly, rather than monthly, which may then reduce the amount of interest you are charged, depending on how your lender calculates repayments.

Can I take a personal loan after a home loan?

Are you struggling to pay the deposit for your dream home? A personal loan can help you pay the deposit. The question that may arise in your mind is can I take a home loan after a personal loan, or can you take a personal loan at the same time as a home loan, as it is. The answer is that, yes, provided you can meet the general eligibility criteria for both a personal loan and a home loan, your application should be approved. Those eligibility criteria may include:

  • Higher-income to show repayment capability for both the loans
  • Clear credit history with no delays in bill payments or defaults on debts
  • Zero or minimal current outstanding debt
  • Some amount of savings
  • Proven rent history will be positively perceived by the lenders

A personal loan after or during a home loan may impact serviceability, however, as the numbers can seriously add up. Every loan you avail of increases your monthly installments and the amount you use to repay the personal loan will be considered to lower the money available for the repayment of your home loan.

As to whether you can get a personal loan after your home loan, the answer is a very likely "yes", though it does come with a caveat: as long as you can show sufficient income to repay both the loans on time, you should be able to get that personal loan approved. A personal loan can also help to improve your credit score showing financial discipline and responsibility, which may benefit you with more favorable terms for your home loan.

How do I calculate monthly mortgage repayments?

Work out your mortgage repayments using a home loan calculator that takes into account your deposit size, property value and interest rate. This is divided by the loan term you choose (for example, there are 360 months in a 30-year mortgage) to determine the monthly repayments over this time frame.

Over the course of your loan, your monthly repayment amount will be affected by changes to your interest rate, plus any circumstances where you opt to pay interest-only for a period of time, instead of principal and interest.

Remaining loan term

The length of time it will take to pay off your current home loan, based on the currently-entered mortgage balance, monthly repayment and interest rate.

Who has the best home loan?

Determining who has the ‘best’ home loan really does depend on your own personal circumstances and requirements. It may be tempting to judge a loan merely on the interest rate but there can be added value in the extras on offer, such as offset and redraw facilities, that aren’t available with all low rate loans.

To determine which loan is the best for you, think about whether you would prefer the consistency of a fixed loan or the flexibility and potential benefits of a variable loan. Then determine which features will be necessary throughout the life of your loan. Thirdly, consider how much you are willing to pay in fees for the loan you want. Once you find the perfect combination of these three elements you are on your way to determining the best loan for you. 

What is a fixed home loan?

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

What is the best interest rate for a mortgage?

The fastest way to find out what the lowest interest rates on the market are is to use a comparison website.

While a low interest rate is highly preferable, it is not the only factor that will determine whether a particular loan is right for you.

Loans with low interest rates can often include hidden catches, such as high fees or a period of low rates which jumps up after the introductory period has ended.

To work out the best value for money, have a look at a loan’s comparison rate and read the fine print to get across all the fees and charges that you could be theoretically charged over the life of the loan.

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

Monthly Repayment

Your current monthly home loan repayment. To accurately calculate how much you could save, an accurate payment figure is required. If you are not certain, check your bank statement.