Interest rate options

Variable Rate

The most common interest rate type with Australian borrowers. Under this form of interest, the initial and ongoing rate is set by the lender, and the lender reserves the right to review the interest rate at any time.

Variable rate loans generally have no restrictions or penalties for making additional repayments therefore you may be able to pay off your loan sooner. Additionally variable rates will be advantageous when interest rates fall, as your monthly minimum repayment will fall along with the amount of interest charged, but will be dis-advantageous when rates increase.

Variable rates offered by lenders are subject to change in line with the Reserve Bank of Australia’s movement in official cash rates, however due to funding pressures and other economic factors, the Australian public have seen some Lenders increase their variable rate by more than the official RBA rate movement, much to the ire of many borrowers.

Fixed Rate

The majority of Lenders offer fixed rate loans, mainly for 1 to 5 years but in some cases for 7, 10 or even 15 years. At the end of the fixed term, the interest rate usually converts to a standard variable. 

With a fixed rate loan, your interest rate remains the same during the entire fixed rate term, regardless of the lender's variable rate movements or RBA movements. The interest rate offered by the Lender over a specified term is usually indicative of where they think the variable rate will be in 3 or 5 years (or whichever fixed term you elect) and will typically be much different to what their rate offering is on a basic variable loan at time.

Fixed rates offer some certainty in calculating what your repayments will be whilst the loan is fixed however if variable rates decrease over your fixed rate period, then you could end up paying more for your loan. Fixed rates usually carry restrictions with regards to making extra repayments so this can be shortcoming for some borrowers who want to make extra repayments along the way.

If a fixed rate loan is repaid in full, or by more than the agreed threshold as set by the lender during the fixed rate period, a penalty fee known as a Break Cost may be payable. Please refer to the FAQ’s for a full explanation of Break Costs.  

Principal and Interest Home Loan

Principal is the actual money you have borrowed and interest is the fee lenders charge you whilst you owe this money. A Principal and Interest home loan (P&I) is simply one which includes an allocation for repayment of the principal together with the interest charge in your regular minimum repayment.

Your loan is repaid with each installment with reduces interest costs and increases the equity in your property. Minimum repayments are higher as they include the interest charge together with an allocation for principal.

Interest-Only Home Loan

Repayment of the principal is deferred for an agreed period (usually 1-5 years or up to 15 years with some lenders) and during this time you only pay the interest charges which results in a lower minimum payment as there is no allocation for principal.

At the end of the interest only period  you must start making Principal and Interest Repayments over the remaining term of the loan, although some lenders will also allow you to extend the interest only period for a further term.

This option is often used as part of a negative gearing strategy for investment property as it preserves the original amount borrowed, thus maximizing the interest charges and resultant interest deduction to offset the income generated from the property, however you should seek independent financial advice as to whether this option suits your individual situation & investment strategy.

Interest in Advance

Interest in Advance (IIA)  is an option on interest only fixed rate investment loans, whereby you pre-pay next year’s interest (before June 30) and claim it back as a deduction this year. Your Accountant may recommend this strategy in the event you have a large tax liability for the current financial year as this lump sum of interest paid now can offset your tax liability in the form of a deduction for the current tax period. Many Lenders will offer a discount off the standard fixed rate for paying Interest in Advance and the amout of interest paid can cover from 6 months up to 13 months.

Interest Capitalisation

Capitalising interest occurs when accrued or accumulated interest is added to your loan principal instead of being repaid month to month. With capitalising interest, the loan amount continuously increases, and so does the total cost of the loan (including interest and ongoing fees). Essentially, the borrower is using borrowed money to pay out the loan and are paying interest on your interest. As a result, you pay more and more interest over time.