Principal and interest on home loans

If you’re in the market for a new home loan or refinancing an existing home loan, it is important to understand how you intend to manage your interest repayments. You can either make repayments on a ‘principal and interest’ basis or pay by ‘interest-only’ instalments. To work out which option is best for you, try using our home loans calculator.

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 – the results might just surprise you!

Principal and interest loans

Making principal and interest (P&I) repayments, helps to trim the principal (or ‘capital’), as well as the mortgage interest on 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 option can be a smart choice if you intend to live in the property for a long time. By paying off the capital, you not only increase your own equity stake in the property, but this strategy will result in outright home ownership. Moreover as you pay down the principal, you’ll simultaneously help to reduce the interest you’ll pay over the term of the loan.

Interest-only loans

On 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. Most lenders offer interest-only loans for a limited time – up to 5 years in some cases – after which you either need to start paying back the principal, or you must reapply to continue paying the home loan on an interest-only basis.

How they stack up

Let’s take a $400,000 home loan as an example at a rate of 7 percent interest and loan term of 25 years. Paying the principal and interest option might set you back around $2800 per month, while the interest only option might seem more affordable at around $2300 per month. Now, consider the total amount of interest paid on each option – around $448,000 overall when paying principal and interest compared to a whopping $700,000 in total for the interest-only option!

To determine the overall costs of your home loan, visit RateCity and use our home loans calculator and compare some of Australia’s best home loans.

 

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Learn more about home loans

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.

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.

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.

Mortgage Calculator, Repayment Type

Will you pay off the amount you borrowed + interest or just the interest for a period?

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.

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.

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.

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.

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.

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.

How do I know if I have to pay LMI?

Each lender has its own policies, but as a general rule you will have to pay lender’s mortgage insurance (LMI) if your loan-to-value ratio (LVR) exceeds 80 per cent. This applies whether you’re taking out a new home loan or you’re refinancing.

If you’re looking to buy a property, you can use this LMI calculator to work out how much you’re likely to be charged in LMI.

What happens when you default on your mortgage?

A mortgage default occurs when you are 90 days or more behind on your mortgage repayments. Late repayments will often incur a late fee on top of the amount owed which will continue to gather interest along with the remaining principal amount.

If you do default on a mortgage repayment you should try and catch up in next month’s payment. If this isn’t possible, and missing payments is going to become a regular issue, you need to contact your lender as soon as possible to organise an alternative payment schedule and discuss further options.

You may also want to talk to a financial counsellor. 

How personalised is my rating?

Real Time Ratings produces instant scores for loan products and updates them based what you tell us about what you’re looking for in a loan. In that sense, we believe the ratings are as close as you get to personalised; the more you tell us, the more we customise to ratings to your needs. Some borrowers value flexibility, while others want the lowest cost loan. Your preferences will be reflected in the rating. 

We also take a shorter term, more realistic view of how long borrowers hold onto their loan, which gives you a better idea about the true borrowing costs. We take your loan details and calculate how much each of the relevent loans would cost you on average each month over the next five years. We assess the overall flexibility of each loan and give you an easy indication of which ones are likely to adjust to your needs over time.