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How much of your home loan repayments are interest?

Have you ever stopped to consider what proportion of your home loan repayments cover your principal loan amount, interest rate and fees? In this article we break down what your repayments cover and what you can do to pay less interest over time.

Reviewed and updated 20th February 2019

Your home loan is made up of a principal loan amount and the interest you must pay within the loan term. In addition, you may also incur a number of fees over the life of the loan such as: one-off establishment or application fees; ongoing fees such as redraw facility or offset account keeping fees; ’break’ costs should you break your fixed rate mortgage; or discharge fees for paying out your mortgage in full.

Most lenders offer several types of home loans including:

Fixed v. variable home loan

A fixed rate loan is a loan that has a fixed interest rate and therefore fixed loan repayments. The time period of these loans can vary, but you can usually “lock in” your repayments for between 1-5 years. Although the fixed rate period may be 3 years, the loan term may still be 20-30 years.

At the end of the fixed loan period you can decide whether to fix the loan again for a specified time and interest rate, or convert the loan to a variable interest rate for the remainder of the loan term.

The rate charged on a variable loan changes in accordance with a number of factors, primarily, the official cash rate set by the Reserve Bank. Australians have benefited from an extended period of a record low cash rate which has resulted in the lowest interest rates in decades.  It is fair to assume that interest rates will not stay low forever and borrowers should prepare for eventual rate rises.

Interest-only v. principal and interest

As the name suggests, with an interest-only home loan, you pay only the interest charged on the loan for a specified period of time - usually up to five years. In other words, throughout the entire interest-only period, you do not pay down the principal at all. 

A principal and interest loan means you pay both the principal loan amount and the interest each time you make a repayment, which allows you to build equity in your home and pay off your mortgage sooner.

How much interest you will pay over the life of your loan?

To start with, you’ll need to know the interest rate you’re paying on your loan. Then, use our home loan repayment calculator to work out your estimated repayments over your loan term. You can tweak the settings on the calculator to suit your loan type and interest rate, so you can see how much you’ll be paying over the life of the loan and the positive impact extra repayments can have over the long-term.

How you can reduce the interest you pay?

One way you can reduce the interest you pay over the life of your loan is through an offset account attached to your mortgage. The money held in this account is used to offset the interest charged on your home loan each month. You may pay for the privilege of an offset account, so ensure you’re getting the most out of it by keeping money in the account.

Consider depositing your savings, lump sum payments, bonuses and your salary into the account every month to reduce the amount of interest you pay on your loan. Essentially, the more you keep in your offset, the less interest you’ll pay.

Make additional repayments

Home loan interest rates are the lowest they’ve been in decades and many experts are speculating that it’s only a matter of time before they rise across the board. If you can afford to do so, take advantage of this low rate environment and make additional repayments to get ahead while you can. A repayment buffer is a great way to safeguard against eventual rate rises. Moreover, it can protect you if you’re not be able to meet repayments in future.

If you have a redraw facility on your home loan you may be able to access the extra repayments. However, you may be charged for accessing these funds and you’ll reduce the interest savings you would have made.

Generally speaking, most variable rate home loan products will allow you to make additional repayments. Fixed rate home loan products will usually have a limit on the number of extra repayments you can make so it’s important you check your loan terms and conditions if you want to get ahead on repayments.

Speak to your local Mortgage Choice broker to get a home loan health check and find out if you are still in the right loan for you. This is a great way to see how you’re tracking with your home loan repayments and identify any ways you might be able to reduce the interest you pay.

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