How does home loan interest work? See on statements

What is home loan interest?

Lenders charge you for using borrowing money and the main cost is usually the home loan interest. That is why home loan interest rates get so many attention-grabbing headlines.

You often see home loan advertising and paperwork interest is expressed as a percentage. It is all theoretical until you actually have a home loan. That is when you see in “dollar terms” how home loan interest works.

If you want to see how it appears, look at this marked up extract from a home loan statement. It is a classic column presentation of monthly repayments and interest charges for a home loan – debits, credits and a running balance.

Debits increase the loan balance. These could be charges (interest, fees) or withdrawals (accessing advanced payments).

Credits reduce the amount owed—like repayments.

The reason for the variations in monthly interest charged above are many. The following are example of changes that cause the home loan interest cost to fluctuate:

• Number of days in preceding month
• Interest rate changes
• Outstanding balance owed
• Offset balance

How does home loan interest work?

How home loan interest works is the same for most Australian lenders. Interest charges are calculated each day that a loan remains outstanding.

So, while you might have an annual interest rate, your lender breaks it down to a daily rate at the end of each day to work out your interest charges.

How the home loan interest is calculated will depend on your loan structure. But in simplest terms the following numbers are used:

• Current home loan balance
• Interest rate per year

Each day a lender will calculate the amount of interest due. To calculate the interest cost per day, the interest rate is converted to a daily rate. See the example below:

Lenders keep a tally of the daily interest costs and typically charge (debit) it to the borrowers loan account at the end of a monthly cycle.

Interest calculations are not the same as calculating home loan repayments. The daily interest costs calculations are the same whether regardless of the type of loan repayment you make. Whether you are on interest only or principal and interest repayments, the interest cost is still usually tallied daily.

Some key variables can influence the home loan interest costs:

• Interest rate
  The higher the home loan interest rate the higher the cost.

• Current home loan balance
  Lower loan balances incur lower interest costs.

• Offset balance or advanced payments
  Offset accounts can have the effect of lowering the amount of home loan interest able to be charged.

Anything you can do to move these variables in your favour can reduce home loan interest costs.

The RBA cash rate and interest rates

Chances are you have recently read, seen or overheard a conversation about the Reserve Bank of Australia (RBA) making changes to the cash rate.

It costs money to lend money and a significant part of this is related to the cash rate target set by the RBA. The cash rate target gets a lot of headlines each time it moves because it determines the rate banks pay each other for overnight loans—which in turn affects the interest rate for home loans.

Lenders ultimately make their own decision on rates. That way they can adjust their profit margins as needed. Remember banks are in the business of making money.

So, when the Reserve Bank moves the cash rate (up or down), banks usually follow if they have not already.

Home loan clients often ask me where the cash rate is heading. I can only refer them to expert economist commentary in the area as truth is – no one knows.

The variable home loan rates usually rates track above the cash rate. I have put together a chart covering the last few years showing how the variable rate for lending has tracked above the RBA’s target cash rate.

What does home loan interest mean in real money terms?

You might be wondering, how home loan interest works in terms of “dollar-bucks”? (to borrow a phrase from my little nephew).

Discussion about home loan interest is often about rates but in my opinion, we do not talk about dollars enough. Days turn into months and months turn into years. Understanding how home loan interest works can be key to paying less of it.

Take the following loan as an example:

The above home loan interest rate calculation shows how much interest can cost on a $600,000 home loan with principal and interest repayments over 25yrs. An interest calculation of $115 on day one can become over $40,000 in first year.

The below graph shows how home loan interest can reach over $600,000 during a 25yr loan term, assuming minimum P&I repayments are made.

Daily home loan interest calculations can just be a number, but over a loan term can be life changing.

In my article on principal and interest repayment hacks, I share some great tips on how to minimise your home loan interest.

The impact of different home loan interest rates

Home loan interest rates are key in determining how much spare cash you have after making your minimum home loan repayments each month.

Depending on your product, home loan interest rates may move up or down, so can affect:

• Minimum repayments calculations
• Home loan interest cost calculations

In short, home loan interest rates are important to borrowers—very.

Have a look at the example below to see the difference interest rates can have on overall cost of a home loan.

Comparing different home loan interest rate calculations highlights the dollar impact rates have for borrowers. Reducing interest rates might alleviate cost of living pressures for some borrowers. For others, over the longer term, can impact bigger wealth-related goals—like retirement.

What if I told you that in a six-month period at the end of 2018, I saved my home loan clients over $300,000 in forecast two-year savings? This is real money that could have been paid to lenders if nothing was done.

No clients refinanced to another lender. I got them better home loan rates by approaching there lender – I share how you can try the same here.

These are regular people like you – friends, families who mostly live locally. Because of my mortgage broker know-how, these clients avoided paying a forecast $163,000 in interest to lenders in year one, not to mention beyond.

If you have a home loan.

If you want to pay the bank as little as you can.

If you want to a lower rate.

I share how to give it a go here.

Home loan interest – Where to find it on a statement

Every night at the end of the business day the bank calculates the interest you owe.

Then they do it again the next night.

This amount climbs and once a month they charge you for it. It can be silent in nature. Just hits your loan account as a debit (a negative/minus/charge).

Below I share a marked up extract of a home loan account showing how home loan interest can appear on an account.

This example shows consistent principal and interest payments with varied interest amounts—quite typical.

The credit is in GREEN, but the interest cost shows as normal font black with a minus sign. I wonder if we would pay more attention to it if it was in BOLD RED?

So interest costs can appear on your statement as inconsequential from a font point of view. In reality, home loan interest can be a very silent drain on your finances over the life of the loan.

Now you know how home loan interest works and where to find it, see what a rate difference could do for you. Follow my Insider Guide to getting discount on your home loan.

Trusted help with home loan interest rates

Mortgage brokers are licensed professionals who must act in your best interest. If you need clarification or guidance in the home lending space I can put you in touch with broker who is legally compelled to act in your best interests.