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How is your mortgage interest rate determined?

Being aware of the factors affecting your mortgage interest rate may help you position as a low-risk borrower and score a rate reduction. Here we explain the factors influencing interest rates, so you can increase the likehood of securing the best rate for your needs.

Mortgage interest rates are a big factor in loan repayments and the total cost of home loan. Because a home loan is a significant, long-term debt, even a small difference can really add up over time. So it’s important to secure the best mortgage interest rate for your needs, as well keep across interest rate changes to maintain your financial strategy.

Comparing mortgage interest rates can be confusing and it may be difficult to discern the best interest rate for your individual financial situation. It’s easy to talk about a “standard mortgage interest rate” in a hypothetical way – but in practice, different lenders can offer mortgage interest rates that are relatively similar on the surface, while having quite a bit of variance underneath.

Another big surprise for many borrowers is that the “typical” mortgage interest rate can fluctuate quite a bit from what a lender advertises. Closer inspection of the fine print will often reveal that the interest rate covers a spectrum, rather than being fixed across all borrowers, as lenders offer discounts on standard interest rates depending upon a borrower’s characteristics.

Being aware of the factors affecting your mortgage rate may help to position yourself as a low-risk borrow to the lender and to score 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

Wider economic factors including wage growth, unemployment, international markets and the general state of the economy all hugely impact mortgage interest rates. The Reserve Bank of Australia (RBA) sets the official interest rate to maintain a healthy economy, and this is one factor that banks take into account when determining lending rates for home loans. Interest rates don’t appear to move by much when looked at as a simple number – sometimes only a fraction of a percent – but each basis point can make a significant difference to the total cost of a loan, and a big difference when you’re working to pay down your mortgage.

Loan structure

When you first lock in a home loan, you’ll choose a fixed or variable interest rate (or commonly a combination of both), each with different rates of interest. A fixed interest rate does not change over a set period of time, and your payments will be predictable each pay cycle. By contrast, a variable interest rate is attached to the market interest rate and will fluctuate with the market.

Loan-to-value ratio

Loan to value ratio (LVR) is the percentage of the total value of the property that you’ve borrowed. Generally, an LVR of 80 per cent or less is considered lower risk by lenders for most standard types of home loans. An LVR over 80 per cent may have you attracting a slightly higher interest rate. Even if you’re offered a comparable rate with a lower deposit, you’ll have to pay lenders mortgage insurance (LMI), which will increase your overall borrowing cost over the lifetime of your loan.

Credit history

Credit scores and mortgage interest rates are closely linked. People with a higher credit score are more likely to be eligible for a larger loan and better deal when it comes to interest rates as you are a low-risk borrowers in the lenders’ eyes. If you’re concerned your credit score may impact your borrowing capacity and ability to secure a good rate, we have some information on how you can improve your credit rating.

Type of loan

If you’re self employed but cannot prove your income or don’t have required documentation, you may be able to get a low doc loan. However low doc loans generally attract higher interest rates. Similarly, construction loans with progressive draw down functions at various stages of construction also generally have higher interest rates.

Type of lender

Non-bank lenders typically charge a higher interest rate than the mortgage bank lenders; however, they’ll usually be willing to lend to a broader range of borrowers. But even among the major lenders, it’s not unusual to see some variance from company to company.

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 will 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 attracted sizeable discounts from lenders. Borrowers of larger loans have greater bargaining power and lenders are sometimes more willing to offer discounts as there are fixed costs with writing loans, irrespective of the loan size.

History with the lender

If you’ve previously had a mortgage and paid it back on time, your lender may be more willing to negotiate with you on an interest rate.

Securing the best mortgage interest rate for your needs

Interest rates are important when you’re applying for a home loan, but aren’t the only factor to consider. Choosing the lowest interest rate won’t necessarily give you the best value and have you paying off your loan as quickly as possible.

Home loans come with different options and features. When you have the right home loan that has features to suit your situation, you may be able to minimise fees and use your loan’s features to help you own your home sooner.  For example, an offset account may mean you pay a higher interest rate, but the financial benefit it provides would have you saving thousands of dollars and years of repayments off the lifetime of your loan.

It’s important to weight up if additional features are worth it for your individual circumstances. For example, if your offset balance will always be low (e.g. under $10,000), it may not be worth paying a higher rate for this feature and a basic loan might be a more suitable option.

The value of a mortgage broker

So with all these factors at play, how can you get a better deal for yourself? With all the lenders, rates and options, navigating mortgage interest rates can be tricky. If you’re looking to get a mortgage, or think you could be getting a better deal on your existing mortgage, we highly recommend using a good mortgage broker.

At Financial Spectrum we offer a range of financial services – and we can also recommend mortgage brokers who can secure you competitive finance solutions tailored to your individual needs.  To find out more, get in touch today for an appointment.

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