Factors Determining Your Mortgage Interest Rate: A Detailed Overview
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When you take out a mortgage, there are a number of factors determining the interest rate you will pay for your home or investment loan. Here we quickly take a look at several of the variables that will determine your interest rate.
Owner-occupied vs Investor
As the name suggests, purchasing a property to live in or a property as an investment implies different intentions. When you apply for a home loan to help you buy a house or to refinance an investment property, you need to specify whether you are applying for an owner-occupier loan or an investor loan.
The distinction will change the rate at which you’ll be charged interest. Owner-occupied mortgages will provide you with a lower rate of interest compared to an investment mortgage. This applies to all lenders, whether you choose an offset mortgage, variable rates, fixed home loan, or construction financing. Investment loans are usually more expensive than owner-occupied in interest rates
You may have to put down a larger deposit for an investment home loan, meaning your maximum loan-to-value ratio (LVR) will be lower. Many Australian banks and lenders have lowered the maximum LVR to around 90% for investment loans.
Principal & Interest vs Interest Only
Where the borrower repays the loan as well as the interest charged by the lender from the start of the term, this is called a Principal & Interest loan (P&I). So from the start, your regular repayments will pay down the loan amount(the principal) plus the interest that’s added on top.
Principal and interest are generally the most common loan setup, with the main alternative being an interest-only loan. With that kind of loan, your repayments will cover the interest charged by the lender for a period of time only, usually up to five years in the case of an investment loan. After this period, the loan reverts to principal and interest repayments.
Principal and interest repayment (P&I)will always mean a lower interest rate, as this form of repayment reduces the risk for the lender with the mortgage being paid down with each repayment.
In order to assist with cash flow, many property investors will opt for interest-only repayments (I/O), however, the interest rate will usually be higher.
Loan-to-value ratio (LVR)
LVR is the amount you need to borrow, calculated as a percentage of the value of your property. For Example, if your loan amount is $400K and your property value is $500K, then your LVR is 80%.The larger the cash deposit or equity that you have, the better, as this will lower your loan-to-value ratio (LVR), with the ideal position for the lowest interest rate being an LVR under 70%. Any LVR where lenders mortgage insurance is required will usually mean a higher interest rate.
The more you borrow with one lender will usually end up in your favor because you will obtain a larger discount on your mortgage, with most of the major banks offering professional packages.
Fixed or variable home loans
Fixed-rate home loans will have an interest rate that is fixed for a set amount of time (usually from one to five years). When the fixed rate term ends, the loan usually switches to a variable rate. Fixed rates means hedging your bets against future interest rate increases, and the fixed rates are usually priced accordingly, depending on whether the market is forecasting a rate rise or fall.
Fixed rates can come with limitations on extra repayments being limited to $10k pa and mostly do not offer interest offset accounts.
If you exit a fixed rate before the expiry date and rates are now lower than your fixed rate, you will likely pay a break cost, which will be the interest over the remaining term of the fixed rate.
Variable-rate home loans have an interest rate that will rise and fall, generally in line with the Reserve Bank, as it adjusts its rates according to market forces. This will impact the amount of interest you pay.
You can have your entire loan set as a fixed rate; your entire loan set as a variable rate; or you can split your loan into fixed and variable portions. This can give you flexibility over the life of your loan.
An offset account- is a savings account that’s linked to your home loan so you can “offset” the amount you owe on your home loan. This means you are only being charged interest on the difference. An offset account is usually better than a savings account as it is working harder for you.
An offset account allows you a faster way of paying off your loan as you use your savings to reduce the amount of interest you pay. You cannot have your entire loan at a fixed rate but must have a portion at a variable rate.