Understanding Mortgage Interest Rates: What Every Borrower Needs to Know
- Jaeneen Cunningham
- 5 days ago
- 5 min read
For most of us, a mortgage is the largest financial commitment we'll ever make. Yet, many borrowers sign on the dotted line without fully understanding one of the most important aspects of their home loan — the interest rate. While the loan amount and repayment schedule may seem like the headline figures, it’s the interest — how it’s calculated, applied, and structured — that can make a substantial difference to your financial future.
In this article, we’ll break down how mortgage interest rates work, explain the different loan types, and explore practical strategies to reduce interest charges over time.
1. What Is a Mortgage Interest Rate?
The mortgage interest rate is the cost a lender charges you for borrowing money to buy a home. It’s expressed as an annual percentage of your loan balance (e.g., 6.5% p.a.). This rate plays a significant role in determining your total loan repayments and the overall cost of your mortgage.
Interest is the lender’s reward for taking the risk of lending you money — and over a 25 or 30-year term, it adds up to a significant portion of your total repayments.
2. How Is Interest Calculated on a Home Loan?
Mortgage interest in Australia is typically calculated daily but charged monthly. This distinction is important.
Daily Interest Calculation
Every day, your lender calculates the interest on the outstanding balance of your loan. Here’s a simple formula used:
Daily Interest = (Outstanding Loan Balance x Annual Interest Rate) ÷ 365
For example, if your loan balance is $500,000 and your interest rate is 6.5%:
($500,000 x 6.5%) ÷ 365 = $89.04 per day (approx.)
If you made no repayments for 30 days, you’d be charged roughly $2,671 in interest for that month.
Why This Matters
Because interest is calculated daily, any money you pay into your home loan — even for a short time — reduces the balance on which interest is calculated. That’s why strategies like making extra repayments or using an offset account can have such a powerful effect on reducing your interest costs.
3. Types of Mortgage Repayments: P&I vs Interest-Only
There are two main types of repayment structures in Australian mortgages:
Principal and Interest (P&I)
This is the most common repayment type. Your repayment includes:
Interest (the cost of borrowing)
Principal (a portion of the loan amount itself)
Over time, the interest portion of your repayment decreases and the principal portion increases, as your loan balance reduces.
Example: On a $500,000 loan over 30 years at 6.5%, your monthly repayment would be about $3,160. Of that, a portion goes towards interest, and the rest reduces your loan balance.
Benefits:
You build equity in your home faster
You pay less interest over time
You’re more likely to own your home outright at the end of the loan term
Interest-Only (IO)
With an interest-only loan, you only pay the interest for a set period (usually up to 5 years). Your loan balance does not reduce during this time.
Benefits:
Lower repayments in the short term
Can improve cash flow for investors claiming interest as a tax deduction
Risks:
No equity built during the IO period
Higher repayments kick in when it converts to P&I
You’ll pay more interest over the life of the loan
4. Fixed vs Variable Interest Rates
When you choose a mortgage, you’ll also need to decide whether you want a fixed, variable, or split interest rate.
Fixed Rate Loans
A fixed-rate loan locks in your interest rate for a set period (typically 1 to 5 years).
Pros:
Predictable repayments
Protection against rising interest rates
Cons:
Limited flexibility (no offset account in most cases)
Break fees may apply if you refinance or repay early
You might miss out if interest rates fall
Variable Rate Loans
With a variable rate loan, your interest rate moves in response to changes in the Reserve Bank of Australia (RBA) cash rate or lender decisions.
Pros:
More flexibility (extra repayments, redraw facilities, offset accounts)
Potential to benefit if rates fall
Cons:
Repayments can increase if rates rise
Harder to predict monthly budgeting
Split Loans
A split loan gives you the best of both worlds — part of your loan is fixed, the other part variable.
This can suit borrowers who want:
Certainty over some repayments
Flexibility to make extra repayments or access features
5. Strategies to Reduce Mortgage Interest
Understanding how interest works means you can implement smart strategies to pay less over time.
Make Extra Repayments
Any extra repayment you make goes straight toward reducing your principal. Because interest is calculated on the remaining balance, this reduces your future interest costs.
Example: Paying an extra $100 a week on a $500,000, 30-year loan at 6.5% can shave over 5 years off your loan term and save you more than $100,000 in interest.
Use an Offset Account
An offset account is a transaction account linked to your mortgage. The balance in this account offsets your loan balance when interest is calculated.
Example: If you have a $400,000 loan and $50,000 in your offset, you only pay interest on $350,000.
Offset accounts are especially powerful if you maintain a high balance (e.g., by depositing your salary and using a credit card for expenses, then repaying it in full each month).
Pay Fortnightly Instead of Monthly
Paying fortnightly instead of monthly means you make the equivalent of 13 full monthly payments per year instead of 12 — helping to reduce your loan faster.
Avoid Interest-Only Unless Strategic
While interest-only loans may be useful in investment scenarios, they often result in higher long-term interest costs. Unless it’s part of a clear strategy (like negative gearing), most owner-occupiers are better off with principal and interest repayments.
Review Your Interest Rate Regularly
Don’t assume your lender is giving you the best deal. If you’ve had your loan for a few years, it’s worth checking the current market.
You might:
Negotiate a lower rate with your current lender
Refinance to a better deal elsewhere
Consolidate debt into your mortgage at a lower rate
Even a 0.5% rate reduction on a $500,000 loan can save you around $150 a month — or $54,000 over 30 years.
6. Other Important Considerations
Comparison Rates
When shopping for loans, don’t just look at the headline interest rate. Look at the comparison rate, which includes most fees and charges. A comparison rate has limitations but it can give you realistic picture of the true cost of the loan.
Redraw Facility vs Offset
Both allow you to reduce interest, but they work differently:
Offset account keeps your funds separate and accessible
Redraw facility lets you make extra repayments and withdraw them later, but some lenders limit access or charge fees
Loan Term
The longer your loan term, the more interest you’ll pay. While a 30-year loan gives lower repayments, choosing a shorter term (or making higher repayments) will reduce your total interest cost.
Conclusion: Knowledge Is Power
Understanding mortgage interest rates isn’t just for finance professionals — it’s essential knowledge for every borrower.
By knowing how your interest is calculated daily, recognising the implications of your loan structure, and taking advantage of features like offset accounts and extra repayments, you can save tens or even hundreds of thousands of dollars over the life of your mortgage.
Your home loan should work for you — not the other way around. With the right knowledge and a proactive approach, you can take control of your mortgage and build a more secure financial future.
Need Help Navigating Your Mortgage?
An experienced mortgage broker, like the team at Etairos Finance, can help you compare options, structure your loan for flexibility, and implement strategies to minimise interest and maximise your wealth. Whether you're buying your first home or refinancing an existing loan, expert advice can make all the difference.
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