Interest Rates…What the??

As interest rates continue to be at an all-time low, we answer some of your most frequently asked questions about interest rates to help you make better informed decisions about entering the property market or about your existing home loan.

How are interest rates determined?

Interest rates on home loans are set by banks and each home loan product will have a different interest rate depending on its features. However, interest rates are strongly influenced by the cash rate set by the Reserve Bank of Australia (RBA). The RBA reviews the cash rate on a monthly basis and will increase, decrease or hold it based on their views of the Australian and international economy. A change to the cash rate will usually be reflected in a change to lender interest rates.

Are banks and lenders required to pass on the RBA’s cash rate cuts or rises?

No. Banks and lenders are allowed to make independent decisions on whether or not they pass on the RBA’s cuts or rises to their home loan rates.  There are a number of factors that determine their decision but usually they will follow suit.

What happens if a lender doesn’t pass on a rate cut? If a lender fails to pass the cut on, it is your prerogative to negotiate a better interest rate or look at switching to a lender with a better rate. Of course this only applies to variable interest rates, if yours is fixed, it won’t be impacted.

Negotiating a better rate or switching lenders involves a bit of homework, especially when looking to switch. To ensure it’s the right finance fit for you, you’ll have to calculate discharge/break fees, establishment fees and stamp duty. It’s our recommendation to seek the advice of an expert mortgage broker to find you the solution that’s right for you.

What is a comparison rate?

A comparison rate includes the interest rate and the fees and charges relating to a loan. The aim of the comparison rate is to help you identify the true cost of a loan and compare loans and services offered by banks and lenders.

To simplify, this is what makes up a comparison rate:   The interest rate + fees and charges = comparison rate%

Although a comparison rate is a more accurate representation of the cost than the interest rate alone, a comparison rate does not consider costs such as stamp duty, conveyancing fees, break costs or special loan features.

But don’t worry, if this sounds at all confusing, we’re here to do the calculating for you!

What’s the difference between fixed and variable interest rates?

Fixed rates are just as the name suggests. The interest rate will remain the same for an agreed upon term irrespective of changes to the cash rate made by the RBA, this is generally between 1-5 years.

Why would someone opt for a fixed rate? 

It gives assurance that their rate will not fluctuate with the cash rate, which can go down but can also rise, therefore making their repayments higher. The interest rate will however change back to a variable rate after the fixed rate term is concluded, unless another fixed contract is entered.

Unlike a fixed rate, variable rates will adjust based on the lenders decision to pass on interest cuts or increases. Borrowers may choose to enter this contract with the anticipation of rate cuts, and these contracts often come with more appealing features.

A mortgage broker can help you understand the ins-out-outs of both types of loans and can define which one is most suitable for you.

How do principal and interest loan (P&I) and interest-only loan differ?

Firstly, principal refers to the amount you borrowed. If you have a P&I loan you’ll make regular repayments which include both interest and a portion of the principal to ensure that you loan is repaid within the agreed loan term. Your monthly repayments will be based on your agreed loan term, eg. 30 years.

Whereas, an interest-only loan will allow you to pay only the interest for an agreed time, generally around 5 years. Despite having lower monthly repayments, the interest rate for this type of loan is usually higher, so in the long term you would have paid more. Once this period ends, repayments will increase, so you’ll need to ensure you can make these repayments.

If you’re unsure, it’s important to get the advice of a mortgage broker so they can evaluate your situation and lifestyle to determine your repayment capabilities.

 

Whether you’re a first home buyer, upsizer, investor, refinancer or beyond, get in touch with a Custom Financial Solutions mortgage and finance specialist to find out how you can make the most of record low interest rates.