This video will explain how interest works and why paying your home loan back faster may mean you’ll pay less interest over the life of the loan .
For most home loans the repayments generally cover two things:
Paying back the principal - the amount borrowed and paying back the interest - the cost of borrowing that money.
Understanding how to manage repayments could impact how much interest is paid over the life of the loan.
There are 3 factors in understanding how the interest part of each repayment works: the interest rate; how it’s calculated; and how it’s charged.
Generally, the lower the interest rate the less interest you're charged. But there are different loan types and interest rates to choose from, depending on your situation and goals. Remember - a home loan is a long-term commitment and over the years the market will fluctuate, meaning interest rates will too.
What many people don’t realise is that interest is calculated daily. So every day you have a lower loan balance counts. It's a good idea to review how often repayments are made and when you start making them.
When people first get a home loan, many are surprised to see how much of their repayment goes towards the interest cost compared to their principal.
Here’s a quick example to help explain why. Say you’ve borrowed $400,000, at 4% p.a. for a term of 30 years. The weekly repayments would be set at about $440. Your very first repayment of $440 would go towards about $307 of interest. The rest of your $440 repayment would go towards your principal, which reduces your loan balance. As your loan balance reduces over time, you’re charged less in interest which means you pay more towards the principal with each $440 repayment.
This is why increasing repayment amounts – even by just a little – could have a big impact. By increasing repayment amount this helps pay more towards the principal, which could reduce the loan balance faster.
Our repayments calculator has a tool on the side that lets you see the interest you could avoid paying by increasing the repayment amount.
Don’t worry if you’re not in a position to increase your repayments at the moment. How you manage your loan may change as your life changes, and paying more at times when you’re able to could still make a big difference.
With fixed rate home loans you may be charged to increase your repayments, so talk to us first before you ask to make any changes.
We know circumstances change and you may need to review your home loan’s structure. We’re here to support you along the way.
Watch our other videos to see the different home loan structures.
If you have any questions, talk to us today.