How is interest calculated on a home loan?

Paying interest is understandably a common concern for prospective homeowners, and you may be wondering how this interest is actually calculated. There are a range of factors that influence what interest you will be paying on your home loan, so we have compiled a list of these for your knowledge.

Principal amount

The principal amount is essentially how much you are actually borrowing. If you take your property price, less your deposit, this will be the principal amount for your loan. The higher your principal amount is, the more interest you will pay over the life of your loan. It is worth considering this factor when browsing property for sale, and to make decisions on what is best for your budget. 

Interest rates

Lenders will set an interest rate on your loan, and this will be influenced by many factors including market conditions, your creditworthiness, and other economic indicators. Interest rates can be fixed or variable, and it is important to consider the benefits and drawbacks of these options. 

Loan length

The duration of your loan plays an important role when calculating your interest. For instance, if you have a longer loan tenure you will most likely have lower monthly payments but higher interest payments overall. You will pay less interest, but more capital monthly, on a shorter loan agreement. 

Extra payments

Borrowers may opt to make additional payments to their principal amount to reduce the loan duration and overall interest paid for the life of the loan. However, penalties or fees may be associated with doing this, so it is important to consider if it is a worthwhile investment for you.

Offset accounts

An offset account is linked to your mortgage account, and can help to reduce the amount of interest you pay on your home loan. The offset account is basically a savings account, where the balance of your offset account reduces the balance of your home loan that gets charged interest. For example, if you had an outstanding balance on your home loan of $400 000 but you had $50 000 savings in your offset account, you would only get charged interest on a $350 000 worth of your home loan. By offsetting the amount of your home loan that you are charged interest on, this means more of your repayment is reducing the Principal Balance of the mortgage, and less is paying off the interest being charged, which means you are paying your home loan off faster!

Interest is understandably a concerning factor of home ownership for many prospective buyers. However, understanding how interest is calculated, and what you can do to reduce it, can make buying property a less stressful process. If you need advice on interest, and securing a good rate for your loan, book an appointment with one of our Borro brokers today or call the team on 1300 1BORRO.

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