Understanding the factors that determine your mortgage interest rate can help you present yourself as a low-risk borrower and potentially secure a lower rate. In this guide, we explain the key elements that influence interest rates, enabling you to improve your chances of getting the best rate for your situation.
Mortgage interest rates play a crucial role in loan repayments and the overall cost of a home loan. Given that a home loan is a significant, long-term debt, even a small difference in interest rates can accumulate substantially over time. Therefore, it’s essential to secure the best mortgage interest rate for your needs and stay informed about interest rate changes to maintain your financial strategy.
Comparing mortgage interest rates can be confusing, making it challenging to identify the best rate for your specific financial situation. While it’s easy to discuss a “standard mortgage interest rate” hypothetically, in reality, different lenders may offer rates that appear similar on the surface but vary significantly underneath.
Many borrowers are surprised to learn that the “typical” mortgage interest rate can differ considerably from what a lender advertises. A closer look at the fine print often reveals that the interest rate spans a range, rather than being fixed for all borrowers, as lenders provide discounts on standard rates based on a borrower’s characteristics.
Understanding the factors that influence your mortgage rate can help you position yourself as a low-risk borrower to the lender and potentially secure a rate reduction. Here, we explain how interest rates are determined and the factors that influence them.
Factors influencing mortgage interest rates
The Cash Rate
Broader economic factors such as wage growth, unemployment, international markets, and the overall state of the economy significantly impact mortgage interest rates. The Reserve Bank of Australia (RBA) sets the official interest rate to maintain economic stability, and this rate is a key consideration for banks when determining home loan rates. Although interest rates may seem to change only slightly – often by just a fraction of a percent – each basis point can substantially affect the total cost of a loan and make a big difference when you’re working to pay down your mortgage.
Loan Structure
When you first secure a home loan, you’ll choose between a fixed or variable interest rate (or often a combination of both), each with different interest rates. A fixed interest rate remains unchanged over a set period, making your payments predictable each cycle. In contrast, a variable interest rate is tied to the market interest rate and will fluctuate accordingly.
Loan-to-Value Ratio (LVR)
The loan-to-value ratio (LVR) is the percentage of the property’s total value that you’ve borrowed. Generally, an LVR of 80% or less is considered lower risk by lenders for most standard home loans. An LVR above 80% may result in a slightly higher interest rate. Even if you secure a comparable rate with a lower deposit, you’ll need to pay lenders mortgage insurance (LMI), which increases your overall borrowing cost over the loan’s lifetime.
Credit History
Credit scores and mortgage interest rates are closely linked. Individuals with higher credit scores are more likely to qualify for larger loans and better interest rates, as they are seen as low-risk borrowers by lenders. If you’re concerned that your credit score might affect your borrowing capacity and ability to secure a good rate, we have information on how to improve your credit rating.
Type of Loan
If you’re self-employed and cannot prove your income or lack required documentation, you might be eligible for a low doc loan. However, low doc loans generally come with higher interest rates. Similarly, construction loans with progressive drawdown functions at various stages of construction also typically have higher interest rates.
Type of Lender
Non-bank lenders usually charge higher interest rates than mortgage bank lenders but are often willing to lend to a broader range of borrowers. Even among major lenders, it’s common to see some variation in interest rates from one company to another.
Loan Purpose
Will you be living in the property you’re taking out a loan for, or is it for an investment property? Investment property loans generally attract higher interest rates than owner-occupier loans, as lenders typically view investors as higher-risk borrowers.
Mortgage Size
Borrowers applying for larger loans have traditionally received sizeable discounts from lenders. Larger loan borrowers have greater bargaining power, and lenders are sometimes more willing to offer discounts since there are fixed costs associated with writing loans, regardless of the loan size.
History with the Lender
If you’ve previously had a mortgage and repaid it on time, your lender may be more willing to negotiate a favorable interest rate with you.
Securing the Best Mortgage Interest Rate for Your Needs
While interest rates are crucial when applying for a home loan, they aren’t the only factor to consider. Opting for the lowest interest rate doesn’t always guarantee the best value or the quickest loan repayment.
Home loans come with various options and features. Choosing the right home loan with features that suit your situation can help minimize fees and utilize the loan’s features to help you own your home sooner. For instance, an offset account might come with a higher interest rate, but the financial benefits could save you thousands of dollars and reduce the repayment period significantly.
It’s important to evaluate whether additional features are worth it for your specific circumstances. For example, if your offset balance is consistently low (e.g., under $10,000), paying a higher rate for this feature might not be worthwhile, and a basic loan could be a better option.
The Value of a Mortgage Broker
With all these factors in play, how can you secure a better deal for yourself? Navigating mortgage interest rates can be complex with the multitude of lenders, rates, and options available. If you’re looking to get a mortgage or believe you could get a better deal on your existing mortgage, we highly recommend using a good mortgage broker.