Mortgage Rates Explained

Interest rates play a large role in our lives especially for the potential home owner and mortgage owner. So, it certainly can't hurt to take a closer look at what they are all about....

Interest Rates Chart:


What is Interest?
Interest is a fee paid on borrowed capital or put another way "rent on money".The fee is compensation to the lender for foregoing other useful investments that could have been made with the loaned money or principal amount.

What is the 'Principle'?
The amount of money loaned to the borrower is called the principal. Interest is paid on the principal at a reducing rate.

What is a 'Reducing Interest Rate'?
As opposed to a flat rate, a reducing rate means that the interest charge is calculated against the principal amount outstanding. Therefore, as the principal is paid off the interest charge reduces. For example:

$500,000 loan at 10%
The annual interest payable is 10% of $500,000 = $50,000
The daily interest charge is then $50,000 / 365 days = $137

So, for everyday that there is $500,000 owing there will be interest payable of $137. If the principal amount is reduced to $400,000 the interest charged annually reduces to $40,000 and daily is $109. So in this example, as the principle reduces so does the interest charge.

In this case making extra repayments can help reduce the total cost of the loan for example by using the additional payment calculator (with the details: $500,000 at 10% over 30 years) it can be seen that simply making an extra payment of $20 each month (a total of $7200) that it saves over $36,000.

Cheaper rates are not always the cheapest
One lender may offer a cheaper rate compared to other lenders but is it the cheapest? It may pay to calculate the total cost of the loan as by the time you add in fees and charges over the term of the loan it may not be cheaper at all. Also to be considered is the features or benefits the particular loan offers that may be worth trading off over the interest rate. A handy tool here is the comparison rate

What is the Comparison Rate
A comparison rate is a tool to help consumers identify the true cost of a loan. It is a rate which includes both the interest rate and fees and charges relating to a loan, reduced to a single percentage figure. It doesn't take into account event based fees such as exit fees or redraw fees.

Who sets mortgage interest rates?
Immediately we think of the bank or lender, being the person who we deal with, setting the interest rate although this is only partly true. There is also a cost to the banks for the money they obtain to then lend out.

This cost can be from the interest rate the lender pays to a depositor and the cost of money in the market. The money market is where the RBA (Reserve Bank of Australia) acts to set what is called the cash rate.

What is the Cash Rate?
The cash rate is the interest rate charged on overnight loans between financial intermediaries (e.g banks). As the RBA writes - It has a powerful influence on other interest rates and forms the base on which the structure of interest rates in the economy is built. The RBA 'controls' this cash rate as a tool for achieving Monetary Policy outcomes. More about the RBA and Interest Rates