Home loan repayments refer to the regular payments you make to your lender to pay off your debt over a fixed duration or term. The size of your repayment depends on various factors, including the size of your loan, your interest rate, the loan term, and the repayment frequency you choose.
What are the different types of mortgage repayments?
You can choose from two types of repayments – principal and interest repayments or interest-only repayments.
Principal and interest repayments consist of two elements – a small part of the principal (or the actual money you borrowed) and the interest charged on the loan during a period. On the other hand, an interest-only repayment only requires you to pay the interest charged on the loan for a set duration – usually up to five years. You don’t pay off your home loan principal at all during this time.
Most home loans are structured as principal and interest loans, where you regularly pay some of your principal and the interest charged on the loan. An interest-only loan is generally not considered suitable for owner-occupiers.
When you don’t pay off the principal, you don’t build any equity in your home. Besides, your repayments are likely to jump at the end of the interest-only period because you’ll need to repay the principal amount in a smaller period compared to the original loan duration.
Does the type of interest you choose affect your repayments?
The interest you pay on your home loan can be fixed or variable. A fixed rate means you can lock the interest on your mortgage for a set period, usually up to five years. On the other hand, a variable interest rate means the amount of interest charged to you can change at any time. The lender may increase or decrease the interest rate on your loan in response to the market conditions or the rate changes made by the Reserve Bank of Australia.
Most lenders calculate the interest on your home loan daily and charge it monthly on a specified date. If you have a fixed interest rate, your repayments will not change during the fixed home loan period. However, your mortgage repayments are subject to market fluctuations if you choose a variable interest rate. If your lender announces a rate hike, your repayments will likely increase.
You should consider learning more about the pros and cons of fixed and variable rate home loans to choose the right option for you.
How often should you make your mortgage repayments?
Most borrowers choose to make monthly repayments, but some lenders also allow you to make fortnightly or weekly home loan repayments.
It’s difficult to say what is the right repayment schedule for everyone because it depends on your personal preferences and payroll cycle. However, making more frequent repayments could help you repay your loan faster.
We know that interest is calculated daily on your home loan balance. Paying your home loan more frequently can reduce your loan principal faster, reducing the interest you’re charged on this amount.
Switching to fortnightly repayments from paying monthly can also help you pay a little extra toward your home loan. Each year has 12 months, but there are 26 fortnights in a year because every month isn’t four weeks long. So when you switch to fortnightly repayments, you effectively make 13 monthly repayments, which can help you get ahead on your home loan and also save some money in interest charges.
Here’s an example to understand this better.
Consider a $500,000 home loan at 4% interest and a 30-year term. Your monthly repayments for this hypothetical loan would be $2,387, and the total cost of the mortgage to you would be $859,346. The total interest you pay on the loan during the term would be $359,346.
If you switch to fortnightly repayments, you’ll pay $1,194 to the lender every two weeks, and the total cost of the loan to you would reduce to $802,963. You’ll pay a total interest of $302,963 across the term – a saving of over $50,000.
Does the term of your home loan affect your repayments?
Selecting a longer term for your home loan can help you reduce your repayment size by dividing the principal into more repayments. However, you’ll likely pay more interest on your home loan if you choose a longer duration.
Continuing with the previous example, you’re paying $2,387 monthly over a 30-year term. When you reduce the term to 25 years, your monthly repayment increases to $2,639. However, the total interest payable on the loan reduces to $291,756 – a saving of almost $67,000 compared to a 30-year term.
How to choose the right repayment size for your home loan?
The monthly repayment for your home loan should be an amount you can comfortably afford without considerably affecting your lifestyle. Once you know this figure, you can work backward to find the right-sized home loan for you.
Depending on the size of your loan and your monthly income, a home loan repayment can take up a significant amount of your household budget. That’s why it’s important to calculate your monthly repayments using an online mortgage calculator to find out whether you can comfortably repay the loan.
While researching, you can reduce your monthly repayments by looking for a lower interest rate or increasing the term of your loan. However, a lower interest rate may come without additional features, like a free offset account or a redraw facility that could help you manage your loan better. If you need to access these features, there might be a fee charged to you, which would increase the cost of the loan to you.
Modifying the term of the loan to manage your repayment size is another option, but it could change the total amount of interest you pay over the life of the loan.
If you cannot afford the repayments for a particular loan size, it may be better to downsize by borrowing a smaller amount. You should also consider calculating your repayments at a higher interest rate than what is advertised by lenders to cater for any future rate hikes. If you need help, consider speaking to a mortgage broker to understand your options better.
