Understanding home loan interest rates

Understanding home loan interest rates


When choosing a home loan, it is important to find the right rate option to suit your situation. But with so many offers available from so many lenders, finding the right one can be overwhelming.

How do rates get set, what are the different types, why are they different, and what does ‘comparison rate’ mean? Here we explain everything you need to know about interest rates to help you be well prepared for the homebuying process.

While a lender’s interest rate changes used to be linked to the Reserve Bank of Australia’s monthly cash rate decision, increasingly, lenders are making changes to their interest rates decisions independently.

How are interest rates decided? 
The big influencers on interest rates are:

1. What it costs the lender to offer you a loan
Just like most things that are sold in the market, money comes with a cost for the lending organisation. In Australia, these ‘wholesale’ costs of money – for all lenders – are set by a number of factors, local or global.

Each lender’s funding costs are different. This explains why there are different interest rates on offer in the market.

One of the main factors that influences Pepper’s decision on changing customer rates is when there’s a change in the rate that banks and professional investors charge to lend each other money. This is called the BBSW (Bank Bill Swap Rate). This extends to other lenders as well, and is part of the reason why interest rates don’t always change when the RBA’s cash rate changes. Other factors can include overall business performance, competitive position in market, and changing economic conditions.

When the cost associated with a customers’ loan changes, the lender will often review the rate that the customer is paying and may increase or decrease the customers’ rate accordingly.

2. The 'risk' to the lender
The other important consideration around how home loan rates are set - and another key reason they will vary - is the risk of lending money to a particular customer. Higher risk will often result in a higher rate. The type of things a lender looks for to decide how risky a loan might be are things like the amount of money someone has to put into a property versus how much they are wanting to borrow – called the Loan to Value Ratio (LVR). LVR gives them a good idea about how much borrowing power a person has and the potential risk of lending to them. The more money a person has saved to put into the property, the lower the risk – which is why saving a good-sized deposit is important. 

Lenders will also look at a person’s ability to repay the loan, by checking key things like previous credit history and current financial situation. This type of overall assessment will be used to decide whether a loan can be offered, and at what interest rate. At Pepper Money we use a form of risk-based pricing. This careful process of personal assessment and pricing is what makes us different to the traditional lenders and allows us to provide more types of loans to help a far wider range of people. As a general rule, Pepper Money, like all lenders, wants to be sure that the loan repayments will be able to be comfortably managed within a person’s circumstances and not create hardship.

What are the different types of interest rates (fixed vs variable)?
There are two types of interest rates – fixed and variable. Fixed interest rates will stay the same for the full term of the loan agreement, generally between 1 to 5 years and you’ll pay the same amount at each payment cycle (fortnightly or monthly). With variable interest rates, your loan rate and repayments will go up and down depending on the interest rate changes. This can be helpful if rates go down as the amount of interest you pay will get reduced, but they may also go up making budgeting a challenge. Another benefit of choosing variable rate loans is that it usually gives you the flexibility to make extra repayments or repay your loan in full ahead of the loan term, without paying any additional fees. Learn about the pros and cons fixed vs variable rates here. Note that Pepper does not offer fixed rate loans at the moment – but we are working on it).

Tip: Not all rates are advertised by all lenders. For example, a loan provider might advertise a standard variable interest rate, but they might also have rate discounts or alternative loan options, for example, like interest-only for a number of years. So, it’s a good idea to ask them to take you through all the options they have. 

What’s the difference between an interest rate vs a comparison rate?
Interest rates play a big part when deciding which home loan is best for you. People often focus on the advertised rates without knowing how much a mortgage will really cost. But this is when you need to pay a little more attention to the comparison rate.

The Comparison Rate shows you how much interest you are paying on the loan when all fees and charges are added in, providing you the true cost of the loan, versus the interest rate on its own. Here is a simple example:

  Interest Rate Fees & Charges Comparison Rate
Loan A 4.50% 0.5% 5%
Loan B 4.75% 0.1% 4.85%

As you can see in the table above, Loan A looks more attractive by interest rate – but – when you look at the Comparison Rates that include all the costs, Loan B is the better option.

It is important to understand your exact repayments amount before committing on a mortgage, to ensure that it is affordable for you in the long run.

Tip: As well as understanding the complete costs, you should also compare home loans for any different product features that you are interested in, such as not having any restrictions on early repayments.

Where can I get more information?
Remember there are no silly questions. Always ask. Here are some quick tips:

  • Ask the specialists. Reach out to a broker in your area who can take you through the process and explain everything along the way or get some advice from a number of lending experts. 
  • Get some insights from your own networks. Ask your family and friends for their experience with the lenders you're looking at. You may not have dealt with them before, but others may have.
  • Check for their reviews online. Get a quick overview of how different lenders compare by visiting online comparison site such as Finder, Canstar or Comparethemarket.

Ready to get started? Try our Mortgage Repayment calculator to see what repayments could look like on a Pepper Money home loan. Or if you'd like to know more about our home loan options, enquire online or speak to one of our friendly Lending Specialists on 13 73 77 between 9am and 6pm

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