A home is probably going to be the most expensive investment you’ll ever make. It’s also a major decision that will affect your finances and the well-being of your family for years to come.
However, before a lender will grant you a home loan, they will need to assess how much you can afford in mortgage repayments. This process involves looking at your income, as well as any outstanding debts and ongoing financial commitments you might have.
Also, if you’re buying a property with another person (such as a spouse or sibling), your repayment capacity may be greater (which translates into greater borrowing power). You may want to use one of our mortgage calculators.
To get a general grasp on what your mortgage repayments could be (based on the amount you want to borrow, the interest rate on the loan, as well as the loan period), check out the easy-to-use Home Loan Calculator.
Listed below are some of the factors that can affect your mortgage repayments.
- Interest rates
Interest rates get a lot of attention from homebuyers, and with good reason, as they determine the cost of your home loan and what you’ll need to pay back each month. Even a minor change in interest rates can make a huge difference to your repayments.
The Reserve Bank of Australia (RBA) sets the “cash” interest rate, which is reviewed every month. Credit providers (including the Big Four banks) set their own rates, and can choose to increase or decrease the rates in line with the cash rate.
While interest rates have remained at unusually low levels for several years, it’s prudent to acknowledge that they won’t stay low forever and that even a small increase can significantly affect your repayments and lifestyle.
For example, if interest rates rise and you’re only making the minimum repayments on your home loan, then you’ll have to start paying more. If rates increase just 1%, you’ll have to pay an extra $190 a month on an average home loan of $300,000 payable over 30 years.
Home loans come with different types of interest rates, and each type of interest rate has its advantages and disadvantages.
A fixed rate will allow you to lock in an interest rate on your home loan, typically for 1 to 5 years. This safeguards you from future interest rate increases and helps you plan your finances better as you’ll know exactly how much your repayments will be.
The major disadvantage to a fixed-rate home loan is that you won’t benefit from falling interest rates and there may be restrictions on making additional repayments. Furthermore, you may have to pay a large fee for ending the fixed-rate period on the loan prematurely, particularly if interest rates have fallen since the rate was fixed.
A variable rate means the interest rate on the loan goes up and down in response to changes in the cash rate and other changes initiated by the credit provider.
The advantage of variable rates is that they usually (though not always) go down if the cash rate is slashed, which reduces the amount of interest you’ll have to pay. There are usually no restrictions on making additional repayments, which is great news if you want to clear your mortgage more quickly.
The opposite also applies, and variable rates usually go up if the cash rate increases. This means you’ll have to pay more interest, which in turn increases your mortgage repayments. The rate may also increase even if the cash rate does not.
A partially-fixed rate loan (also known as a split loan) allows you to pay a fixed rate on a portion of your home loan and a variable rate on the rest. For example, if you have a $300,000 home loan, you could choose to pay a fixed rate on $200,000 and a variable rate on the remaining $100,000.
You might consider a partially-fixed rate home loan if you want the security of regular payments on a part of your loan, but also want to take advantage of interest rate drops on the other part of your loan. There are usually no restrictions on making additional repayments on the variable part of your loan.
However, fixing part of your loan gives you less flexibility than a fully variable rate home loan. If interest rates fall, you will only get the benefit of lower interest on the variable part of your home loan. You may also have to pay a hefty break fee if you want to pay out or refinance the fixed-rate portion of your home loan.
How your loan-to-value ratio affects your interest rate
Your loan-to-value ratio (LVR) could affect the interest rate on your mortgage. Your LVR is calculated by dividing the amount of your home loan by the purchase price or appraised value of the property.
Generally, the higher your LVR, the greater the risk to the lender. Hence, some lenders will apply a higher interest rate to loans with an LVR above 80%. With this in mind, it’s important to calculate your LVR and work out what effect it would have on your repayments.
You will also need to pay lenders mortgage insurance if your LVR is higher than 80%.
- Lenders mortgage insurance
Lenders mortgage insurance (LMI) helps prospective homebuyers achieve their dream of homeownership sooner without the 20% deposit that is typically required by most banks and financial institutions. With LMI, lenders will allow you to borrow a higher proportion of the purchase price, thus allowing you to purchase a property with a smaller deposit than would otherwise be required. It may also enable you to borrow at an interest rate that is comparable to a borrower with a larger deposit.
Lenders mortgage insurance could affect your mortgage repayments, depending on how you choose to settle the premium. You can choose to pay your LMI upfront at the time of your loan settlement (which means you won’t have to make ongoing payments).
Alternatively, you could capitalise the premium into your home loan amount so that it’s paid off in increments. In other words, if you add the cost of the LMI premium to your home loan, your repayments will increase marginally to cover the cost of the LMI premium.
If you’re borrowing more than 80% of your home loan, LMI is a mandatory requirement, and your lender will require you to pay this before agreeing to lend you the funds. The amount borrowers have to pay will vary, and is based on the amount they need to borrow, how much deposit they’re able to provide, as well as their loan-to-value ratios.
With LMI, the lender is the insured party, not the borrower or the guarantor (if any). LMI protects the lender against loss if the borrower is no longer able to afford the loan repayments and if the guarantor is unable to meet the liability.
- Home loan deposit (for first-time homebuyers)
If you’re a first-time homebuyer, your home loan deposit is viewed as your “contribution” to the purchase price of the property. The size of your deposit is one of the biggest factors in determining the kind of loan you may be eligible for and the amount you can borrow to purchase your home.
Other factors lenders take into consideration include regular savings deposited into an account over a period of several months, regular rental payments, and sources of income (such as salaries, investments, and dividends). All these work together to give the lender an indication of your ability to maintain your mortgage repayments and greatly determines how much money they’ll lend you.
The size of your deposit can also impact the interest rate on the loan. Having a sizable deposit increases your negotiating power and widens your choice of lenders. With a larger deposit, you may even be able to secure a discounted interest rate from your lender (which can greatly reduce your mortgage repayments).
What’s more, a sizable deposit means you can borrow less from your lender and have less interest to pay over the course of the loan. This in turn would greatly reduce your mortgage repayments.
- Regular lump sum repayments
Whether it’s a bonus at work or a financial windfall such as a monetary gift or inheritance, making a lump sum repayment on your home loan could change your remaining home loan repayment picture significantly. Lowering the amount owed on your home loan may reduce the amount of interest calculated on the remainder, and it may also reduce the duration of your loan.
But how exactly do lump sum mortgage repayments help you save money? The amount of interest you pay on your mortgage will depend on the daily amount you owe. Most mortgages will calculate interest daily, using the outstanding balance and then charging you weekly, fortnightly, or monthly (in line with your chosen payment frequency) to recover that interest.
Essentially, the more money you can pay towards your mortgage, the less interest you will pay (which in turn can greatly reduce your mortgage repayments). You’ll also be able to clear your mortgage debt more quickly.
Here’s a practical illustration of how a lump sum repayment can reduce your mortgage debt. Let’s say you have a mortgage of $500,000 at an interest rate of 7%. Your loan term is 25 years and you are five years into the loan. If you turn a $10,000 windfall into a lump sum repayment, you could reduce your mortgage by 11 months and save $29,212.06 in interest.
Lump sum repayments can be done with any amount of money. In short, the greater the frequency of the payments, the more quickly you’ll be able to clear your mortgage debt and the less interest you’ll be charged.
Borrowers who aren’t locked into fixed-rate or partially-fixed rate home loans should consider making regular lump sum repayments. You can use the Advanced Mortgage Repayment Calculator to see how much you can save if you make extra repayments regularly.