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What is a low interest home loan?

Low interest home loans can offer value by keeping repayment costs down, as the rate at which they charge interest is, by definition, lower than many other home loan products on the market. And when you're shopping for a new home loan, it makes sense to look for a product that offers good value.

Keep in mind, however, that it's important to consider all of the key features of a home loan when you're comparing your options - not just the interest rate.

What is a low interest rate?

Nobody wants to spend more money than they have to, so it’s important to be confident you’re getting a good interest rate on your home loan. But how can you tell what counts as a low rate?

Because banks and mortgage lenders regularly update their home loan offers, it can be hard to know if you’re getting a low interest rate or not. For example, just a few years ago, interest rates below 4 per cent were considered low, but after multiple cash rate cuts from the Reserve Bank of Australia (RBA), it’s possible to find much lower home loan interest rates, including some below 2 per cent. 

The RBA monitors home loan interest rates and tracks the average interest rates for both new and existing mortgage offers. If you can find mortgage offers below the RBA’s average, you may consider these to be low rate loans. 

How important are low interest rates?

Mortgages with low interest rates are understandably popular among borrowers, as they involve paying less money to the lender on top of each instalment of the loan’s principal.

Some lenders offer heavily-discounted “honeymoon rates” as a special offer for the early stage of a loan, which typically revert to standard variable interest rates once this introductory period expires.

On the surface, these may appear to be the lowest interest home loan rates you can find, but if you don’t take into account the introductory period caveat when planning your budget, you could find yourself paying much more than you initially expected.

It’s also important to remember that many lenders also charge fees with their mortgages, which can make a significant impact on the budget of a borrower. These can include upfront fees or application fees, ongoing annual fees, extra or early repayment fees and redraw fees. A mortgage with a low interest rate and high ongoing fees may ultimately turn out to be more expensive in total than a mortgage with a higher interest rate with lower fees and charges.

One way to get an idea of the relative costs of different home loans is to look at their comparison rates, which combine a lender's advertised interest rates with their standard fees and charges.

However, you should keep in mind that a loan’s comparison rate may not take its nonstandard fees and charges into account, or any bonus features offered by the lender that could add extra value to the loan.

What is mortgage stress?

You may know that borrowers can run the risk of mortgage stress if interest rates increase, but what is mortgage stress?

Various banks and mortgage lenders define mortgage stress differently. One common benchmark is when a household has to devote at least 30 per cent of its pre-tax income to servicing its mortgage.

Households that are coping reasonably well with their monthly repayments can find themselves suffering mortgage stress if interest rates suddenly increase, or increase by a significant amount in a short period of time.

For example, between October 2009 and November 2010, the Reserve Bank of Australia increased the official cash rate by 1.50 percentage points. Imagine if you took out a home loan at, say, 4.50 per cent, and your lender then increased your interest rate by 1.50 percentage points over the next 13 months. Here’s what would happen if you had a 30-year loan for $350,000, $500,000, $650,000 or $800,000:

$350,000$500,000$650,000$800,000
Monthly repayments at 4.50%$1,773$2,533$3,293$4,053
Monthly repayments at 6.00%$2,098$2,998$3,897$4,796
Increase$325$465$604$743

The great thing about a home loan calculator is that you can use it to research what would need to happen for you to fall into mortgage stress, and then plan accordingly.

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Why are some home loan interest rates lower than others?

Some types of home loans are more likely to have lower interest rates than others. Generally, the lower the risk that you’ll default on your mortgage repayments, the lower the interest rate you’re likely to be offered on your home loan. 

While the final interest rate you’re offered will likely come down to your lender’s terms and conditions, as well as your own personal financial situation, you may be able to expect a different interest rate depending on whether you’re buying an investment property or a home to live in, planning to make principal and interest repayments or pay interest only, and if you’re looking for a variable or fixed interest rate. 

Principal and interest or interest only repayments?

In most home loans, each repayment consists of a small percentage of the loan amount (the principal), plus an interest charge. Each principal & interest repayment pays off a little more of the loan, and brings you a little closer to paying off your property. 

You may be able to choose to pay only the interest on your mortgage for a limited time, minimising your loan’s short term costs. However, because this repayment type won’t reduce your loan amount, your loan may take longer to pay off, and you may end up paying more interest on your property in total. 

Interest-only mortgages often charge interest at higher rates than principal and interest mortgages, as there’s a risk that a borrower may not be able to afford the loan when it eventually reverts to principal and interest repayments. 

Fixed or variable interest rate?

Once you find a low interest loan, you should be able to calculate the affordability of its repayments. But keep in mind that the mortgage’s low interest rate may not stay that low forever.

Many mortgages have variable interest rates, where the amount of interest the lender charges is affected by the national cash rate set by the Reserve Bank of Australia (RBA). If the RBA keeps the cash rate on hold, the amount of interest you pay should remain steady. If the cash rate is cut, your lender may pass the interest cut on to you, reducing your home loan repayments.

However, the RBA may also choose to increase the cash rate, which could lead to your interest payments becoming more expensive if your lender passes on this rate rise. A sustained period of regular rate rises could lead to your mortgage repayments growing much more expensive than what they were originally, potentially putting you at risk of mortgage stress.

Some lenders fix their mortgage interest rates for anywhere from one to twelve years. This can help to keep your repayments stable and comfortably affordable during the fixed period, which can prove especially valuable to first home buyers hoping to build up their initial equity. However, with one of these fixed home loans, you also won’t benefit from any savings if the RBA lowers the cash rate.

If you’re uncertain whether a variable or fixed rate home loan best suits your finances, you may be able to choose a split rate home loan, which involves paying a fixed rate of interest on a percentage of your loan’s principal, and a variable rate on the remaining balance. A split loan lets you enjoy some of the advantages of a variable rate home loan, such as savings from rate cuts, while at the same time benefiting from the security of a fixed interest rate, which can help keep your repayments from getting too high if rates rise.

Are you an investor?

Lenders offer different types of home loans to owner occupiers and to investors, to better suit the different financial positions of these property purchasers.

While there are always exceptions, home loans for owner occupiers tend to offer low interest rates that are lower on average than what is found in investment home loans. This is partially due to government regulations surrounding investment property lending, and because lenders tend to consider investors to be greater financial risks than owner occupiers.

What else should you look for in a home loan?

There are a number of loan features that can be just as important to consider as the interest rate, such as the length of the loan term and any extra features that may be important to you. Before you get started on your comparison, consider the following:

What loan term should you consider?

If you’re looking at low interest home loans to hopefully minimise how much interest you’ll pay on a property, then you may also want to consider the length of time that you’ll take to pay off your loan amount. Many mortgages start with terms of 25 or 30 years, though shorter and longer loan terms do exist.

By paying back your mortgage over a longer term, you’ll be making a larger number of repayments, each one for a smaller percentage of the principal. This can help to keep your repayments on the low side, so your mortgage remains more affordable from month to month. However, more repayments means more interest charges, so you may ultimately pay more in total interest over the longer loan term than if you’d opted for a shorter term.

A shorter loan term involves paying off your principal over a shorter period. Fewer repayments means fewer interest charges over the life of the loan, so you can ultimately pay less interest on top of your loan’s principal. However, this does mean that each repayment will be for a larger percentage of your loan principal, making your mortgage less affordable from month to month.

If you're looking to refinance your home loan, it's important to consider how far you are into your current loan term so that you don't fall into the trap of extending your loan term without realising. If you are already 5 years into a 30-year loan, for example, refinancing to another 30-year loan could mean losing money in the long run as you might pay more interest over the life of the loan.

How big of a deposit do you need?

Most lenders require you to pay a certain amount of money upfront when you apply for a home loan. This amount varies by lender, but around 20 per cent of the property value is not uncommon. If you’re looking for a low rate loan, you’ll likely need to pay the full deposit to help reduce the lender’s risk.

If you can’t afford a full deposit on the mortgage you’re looking at, there may be other options available to you.

Some lenders can offer a mortgage with a higher Loan to Value Ratio (LVR), where you pay a smaller deposit and borrow a greater percentage of the property’s value instead. However, for these options you’ll likely be required to pay the extra expense of Lender’s Mortgage Insurance (LMI) to help protect the lender in case you default on your repayments.

One option to avoid pricey LMI is a Guarantor loan, where a close relative guarantees your home loan with the equity in their own property in lieu of the full deposit. This option can prove risky for the guarantor though, so be sure they understand what’s involved first.

If you're still in the early stages of the home buying process, you might like to consider using RateCity's borrowing power calculator for an estimate of how much you may be approved to borrow.

Do you need an offset or redraw account?

A low interest rate on your home loan can help to keep your personal finances manageable, but some lenders also offer additional options that can be helpful in this area.

An offset account is a savings or transaction account that’s linked to your home loan. Any money paid into this account is included when the lender calculates its interest charges, which can help you save some money.

For example, if you’ve paid back $200,000 of a $500,000 home loan, and have $15,000 in your offset account, your interest repayments will be calculated on a remaining balance of $285,000 rather than $300,000.

A redraw facility will allow you to withdraw surplus money from your mortgage, provided you’ve made additional repayments. This can allow you to confidently make extra repayments onto your home loan, without worrying about finding yourself short on funds in case of emergency.

Even if you never use the redraw facility, paying extra money onto your home loan will bring you closer to paying it off ahead of schedule and potentially saving money in interest payments. Just me mindful that some lenders may charge redraw fees.

Which bank will give you the lowest interest home loan?

When looking at interest rates on their own, in many cases non-bank lenders will make lower offers than the banks to stay competitive. And as these lenders are often smaller organisations than banks such as the big four (Westpac, NAB, Commonwealth Bank and ANZ), they may be able to offer more personalised services to their customers, or possibly offer more flexible lending criteria to better suit a wider range of borrowers.

However, just because a mortgage has a low rate doesn’t mean it will necessarily offer the greatest value.

It's often good to keep in mind that while the lowest home loan interest rates can be offered by any lender, a low rate home loan that works best for you will likely be better for your needs in the long term. 

Larger banks are often able to offer full home loan packages, bundling the bank’s full range of services (transaction/savings accounts, credit cards etc.) along with the mortgage. Plus, with most banks you’ll have the option to visit a branch to talk over your home loan, which may not be possible with some online-only lenders.

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How do you compare low interest home loans?

When deciding on the right loan type to suit your unique financial situation, low interest rates are just one of many available factors to consider. To make your low interest rate mortgage comparison process easier and more efficient, RateCity collects the essential information regarding a wide variety of home loans all in one place, allowing you to quickly narrow down your shortlist of preferred lenders. 

By using RateCity's home loan comparison tables to help you save time and effort on your home loan search, you can invest more of your energy into working out which loan options will provide features and benefits that will best suit your finances and your lifestyle.

RateCity's mortgage repayment Calculator may also come in handy if you'd like to get an estimate of the potential cost of your weekly, fortnightly or monthly repayments. It allows you to compare different comparison rates, different loan amounts and different loan terms to give you an idea of what your regular repayments might look like.

For information or advice specific to your personal circumstances, you may want to consider reaching out to a financial adviser or mortgage broker.

Before you submit a home loan application, be sure to read the home loan product's eligibility criteria and product disclosure statement (PDS), check for any disclaimers, and enquire directly with the lender if you have further questions or concerns.

What is a mortgage rate?

The interest rate on a home loan is sometimes called the mortgage rate. This percentage indicates how much interest the lender will charge you with each home loan repayment. Your interest rate is effectively the “cost” of “buying” the money you’re using to buy a property – the higher your mortgage rate, the more your home loan repayments may cost.

Using a home loan calculator, you can estimate how much your home loan repayments may cost, based on your mortgage rate, loan term, and loan amount. This may also be affected by whether you’re making principal and interest repayments or interest-only repayments, if you have a fixed rate or variable rate mortgage, and any fees and other charges that may apply.

Is the lowest home loan rate always the cheapest?

The home loan with the lowest interest rate may not always be the cheapest mortgage option for you. Sometimes a home loan with a low interest rate may charge high fees, which may cost more in total than a mortgage with a higher interest rate and no fees.

Consider checking the comparison rate, which combines interest and standard fees, to get a better idea of the overall cost of different home loan options.

What are the different types of home loan interest rates?

A home loan interest rate is used to calculate how much you’ll pay the lender, usually annually, above the amount you borrow. It’s what the lenders charge you for them lending you money and will impact the total amount you’ll pay over the life of your home loan. 

Having understood what are home loan rates in general, here are the two types you usually have with a home loan:

Fixed rates

These interest rates remain constant for a specific period and are a good option if you’re a first-time buyer or if you’re looking for a fixed monthly repayment. One possible downside of a fixed rate is that it may be higher than a variable rate. Also, you don’t benefit from any lowering of interest rates in the market. On the flip side, if rates go up, your rate won’t change, possibly saving you money.

Variable rates

With variable interest rates, the lender can change them at any time. This change can be based on economic conditions or other reasons. Changes in interest rates could be beneficial if your monthly repayment decreases but can be a problem if it increases. Variable interest rates offer several other benefits often not available with fixed rate home loans like redraw and offset facilities and free extra repayments. 

Do you compare mortgages using the comparison or advertised rate?

A lot of Australians compare home loans using the advertised interest rate, which indicates how much interest you’ll be charged on your mortgage repayments. The lower your rate, the cheaper your home loan should be.

However, interest charges aren’t the only cost associated with home loans. Most mortgage lenders also charge fees on their home loans. A mortgage with a low interest rate and high fees can sometimes cost more than a mortgage with a high interest rate and low fees.

A home loan’s comparison rate combines the cost of interest with the cost of standard fees and charges into a single percentage rate. Mortgage lenders are required to display a comparison rate alongside their advertised rate to better indicate the home loan’s overall cost.

Keep in mind that to ensure consistency, all comparison rates are calculated assuming a $150,000 principal and interest mortgage with a 25 year term. As your home loan may be different, the comparison rate may not accurately reflect exactly how much your home loan may cost. Also, the comparison rate doesn’t include every home loan fee and charge, so it’s still important to compare home loans and read the fine print before you apply.

If a mortgage rate changes, will it affect your repayments?

If you have a variable rate home loan, changes to your mortgage rate may affect the cost of your repayments. Rising interest rate could cost you more in interest charges, while interest rate cuts could see you paying less interest on your home loan.

If you have a fixed rate home loan, your interest charges will stay the same during the fixed interest period, regardless of whether the lender’s variable rates rise or fall. Once the fixed rate term expires, your loan will revert to a variable rate, so be prepared in case of bill shock.

This article was reviewed by Personal Finance Editor Alex Ritchie before it was published as part of RateCity's Fact Check process.