How interest rate changes affect your mortgage
Buying a home is one of the most significant decisions a person makes. In a modern landscape where the ratio of homeowners to renters decreases, the emphasis on making an informed financial decision like buying a home is amplified.
Even so, most homeowners don’t consider what home loan rates they are paying. A recent survey conducted on 1,000 Australians suggests that 55% of Australians don’t know their mortgage rate.
The financial implications for the homeowner can be detrimental. A homeowner could be paying double the interest with an interest rate increase as low as 2%.
Understanding your home loan
Buying a home usually requires taking out a loan. Mortgage lenders tend to let you borrow between 80% and 90% of the property value. The amount lent to you is known as the principal amount. Your repayment comprises two separate payments: principal repayments and interest repayments.
The interest repayments are based on the interest calculated from the value of your home loan and are subject to change with rising interest rates, such as those we currently see across the globe.
Understanding your mortgage minimises the risk of getting caught off-guard by rising rates. You can also avoid having to pay an excessive amount of interest.
Calculating a home loan
(principal x rate) ÷ 12 = interest
Interest is calculated annually in percentage terms, known as the Annual Percentage Rate (APR). The monthly interest repayment is calculated by multiplying the principal amount by the interest rate and dividing it by the number of months in a year.
For example, you have a principal amount of $500,000 and an interest rate of 3%. Your calculation of monthly interest will look like this:
($500,000 x 3%) / 12 = $1,250 per month
Why this is important for homeowners
Understanding your home loan is one thing, but knowing how it affects your finances is the real crux of the matter.
Using the year 2022 as an example, a rise in inflation and the subsequent interest rate hikes by the Federal Reserve occurred in order to slow down consumer spending. Unfortunately, this also had a significant impact on homeowners and their borrowing rates.
Increases in interest rates means the monthly interest you pay on your principal amount increases. Essentially, you’ll be paying more to pay off your mortgage, and it could ultimately affect your quality of life.
Following the example above, let’s say the interest rate has increased by 5%.
Your calculation of monthly interest will look like this:
($500,000 x 5%) / 12 = $2,083.33 per month
That is a substantial increase in monthly repayments.
How a mortgage broker can help
The lending landscape is highly complex, and with so many products available to borrowers it’s almost impossible to know which product is right for you. Mortgage brokers have all the necessary information at their fingertips and can provide you with payment options and better rates.
Speak to a mortgage broker for professional advice on how to lower your home loan rate. This simple action can turn out to be one of the best decisions you’ll make.
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