How do interest rates work?

Interest is the fee a lender charges a borrower when they borrow money. It is paid back in addition to the loan amount borrowed. For example, an interest rate of 10% on a $100 loan will result in a total cost of $110 (loan amount plus interest). The higher the rate, the more interest you pay.

Therefore choosing the right home loan for you could save you thousands in the long term.

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Fixed rate vs variable home loans

Fixed rate home loans are usually for a set period of time, ranging between 1-5 years, and have two main advantages. Firstly, they make budgeting easier and secondly, interest rate rises won’t affect your repayments.

However, you may also encounter several disadvantages. Rate drops can become frustrating, as you will be paying more interest than you need. You typically don’t have the freedom to make extra loan repayments if you’re suddenly able to, without paying an additional fee. Additionally, fixed loans may have a break fee, which you will have to pay if you change or pay off your loan earlier than expected.

On the other hand, variable home loans provide greater flexibility and can become lower than what you were initially paying. By the same token, interest rates could also increase meaning, you’d end up paying more than you originally expected. Another disadvantage is you may also have difficulty budgeting for future repayments as the rates are often unpredictable.

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Splitting your home loan

Splitting your home loan is perhaps your best bet if you want to experience the best of both worlds. It is common for people to fix 50% of their home loan as a form of risk management, while simultaneously utilising the benefits of a variable loan, such as making extra repayments.

Ultimately giving people the opportunity to pay off their home loan sooner than expected and affording them the peace of mind that comes with a fixed home loan.

Still not sure which of these options is for you? Have a look at our guide on split, variable and fixed rates.

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