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Buying a home might very well be the largest investment you make in your lifetime. Most buyers have to take out a home loan to afford the cost. But taking out a home loan brings about another major financial commitment – repayments.
Repayments are how the principal sum of your home loan is paid off over a specific period of time, whether that be weekly, monthly or fortnightly. Most lenders allow all of those repayment options, however we’ll look at which options might suit you best, below.
We’ve also included some tips from one of our industry veterans with more than 20 years’ experience, Tim Bowcock, so keep an eye out for Tim’s tips!
Before taking out a home loan, your lender will let you know the minimum amount of money you’ll have to pay each month to service your loan in full. The way repayments work is that, for a 30 year loan, the lender calculates a repayment schedule over 360 repayments (12 months multiplied by 30 years). You need to stick to that schedule at a minimum. You are allowed to get in advance of that schedule by making extra repayments, which we will go over shortly. It should be noted however that, for fixed interest rate home loans, different lenders have different caps on extra repayments, varying between $10k and $30k.
When servicing your home loan, you’re repaying the value of the loan along with the accumulated interest. The value is referred to as the principal and will reduce over the duration of the loan term. What changes is the interest you’re paying on that reducing principal.
At first, the bulk of each repayment will go towards servicing the interest, and the rest will service your principal. With regular payments, you’ll have less principal left to pay near the end of your loan term. As a result, the interest will go down accordingly, so you’ll be paying more and more off the principal until it’s all paid off.
How do lenders calculate my repayments?
Lenders calculate your repayments based on your loan amount and the loan term you opt for.
Let’s look at an example of a $500,000 loan being paid off over 30 years. We’ll use the uno repayment calculator to calculate how much you’ll need to repay monthly, paying principal and interest on a variable interest rate of 4.00%.
As you can see, your monthly repayments come to $2,387.
You can use the uno mortgage repayment calculator to play around with different variables, such as paying off the loan weekly or fortnightly, and reducing your loan term to pay the loan off more quickly.
If we adjust the loan term to 25 years, for example, your repayments become $2,639 a month.
How much interest will I pay over the duration of my loan?
Let’s say you didn’t have to pay interest on that loan (wouldn’t that be nice?!) If you were just paying back $500,000 over 30 years, your repayments would be $1,388.88 monthly (500,000 / 360). So, if we subtract that amount from the amount you’ll pay with interest, you’ll see that you’re paying an extra $1085.12 a month in interest – or $359,346.40 to your lender over 30 years. So the total cost of your loan is actually $859,346.40.
By reducing the term of your loan and paying back the $500,000 over 25 years, you reduce the amount of interest you pay to $972.34 a month – or $291,756.25 over 25 years, so the total amount you pay to the bank will be $791,756.25.
With fluctuating interest rates and an unpredictable financial market, it’s hard to work out exactly how much your loan is going to cost you in the end. But if you repay it before the agreed upon date, you’ll potentially save several thousand dollars over the lifetime of the loan.
Why would I pay off my home loan over 30 years if it’s going to cost me more?
You’re probably wondering why anyone would choose to pay off their home loan over 30 years rather than 20 or 25, if it’s going to end up costing more. Most lenders allow homebuyers 30 years to pay off their loan as it minimises your obligation and provides you with some leeway should your financial situation worsen. If you have the financial capability to pay back your loan over 25 or 20 years, then reducing your loan term will reduce the amount of interest you pay overall to your lender – so it’s a good option.
If reducing your loan term is going to stretch your finances however, you’ll always be better off minimising your obligation and opting for a longer loan term. You can still complete your repayments ahead of the due date and end the term sooner – but you’re doing this on your terms, rather than the lender’s.
Remember, your borrowing power is calculated on your ability to pay back your loan. You don’t want to stretch yourself if it’s going to lead to financial difficulty or put you at risk of defaulting on your loan.
Taking a longer loan term might suit someone who isn’t very disciplined financially, for example. You’ll pay more interest but you’ll minimise your obligation, leaving you more money to spend on other things.
One of the lenders uno works with, Pepper, offers a 40 year loan term. Sometimes people refinance to a longer loan term, even if it’s only in the short term. They may have come into some unexpected financial difficulty, such as a family member getting sick and needing medical treatment; or a car accident that leads to someone being out of work for a period of time. In these situations, the person needs to minimise their repayments and it’s worth it to them to refinance their loan over a longer term to pay a bit more interest to have less financial stress.
Lenders will calculate your repayments on a monthly basis but will give you the option to pay back your loan fortnightly or even weekly. Going from a monthly to a weekly repayment schedule will help you to pay off the loan faster and save on interest.
The maths behind this is very simple. Let’s say you have to pay $1,000 each month at a specified interest rate. As the year has 12 months, you’ll end up paying $12,000 by the end of the year.
However, if you split monthly repayments into four and pay $250 every week, you’ll make 52 repayments a year, which equals $13,000 at the same annual interest rate. So you will have made one extra month’s worth of repayments each year.
It’s the four additional repayments that have the greatest benefit, but also the earlier repayment dates help, because interest is calculated on your loan balance each and every day. If you look at a mortgage statement the interest charged in February is the cheapest month of the year because it only has 28 or 29 days.
With variable rate loans, your interest will sometimes go down and your repayments will be smaller. If possible, you should take advantage of the lower rates and continue paying the same amount of money each month. Because the rates are lower, you’ll be paying more towards the principal, while also saving money and time.
The same applies when you’re refinancing your loan to negotiate a lower interest rate. You should keep your monthly repayments the same even if the interest rate goes down. By doing so, you’ll be paying more towards the principal and thus repay your loan faster.
If you’re very disciplined and can make even larger repayments than your schedule calls for, you’ll be able pay off your loan faster.
Tim’s tip: “If you’re paid weekly, make your repayments weekly. If you’re paid fortnightly, make them fortnightly, and so on – on the day you get paid.”
If your loan documents say your repayment is due on the 10th, you can choose to talk to the lender to make your repayment on the 1st. Basically, you are making the repayment early. Set up the direct debit and you would change it from the 10th of the month to the 1st of the month – when you get paid. The bank is not going to stop you doing that. You will be saving interest charges from the 1st, rather than the 10th.
What happens if I make extra repayments on my loan?
Let’s look at what happens if you choose to make some extra repayments on your loan. Say in the fourth year of your home loan you come into some extra money and you want to make a one-off payment of $5,000 on your loan.
Using the example above of a $500,000 loan being paid back over 30 years at 4.00%, you would have paid off approximately $27,506.45 of the $500,000 principal owing by year four. This leaves you with approximately $472,493.55 left to pay. By paying an extra $5,000 now, you have reduced your loan by six months, and saved $9,571.84 in interest over the life of the loan.
Another example would be if you got a pay rise in year four and were now able to pay an extra $400 a month onto your loan. This would take your monthly repayments to $2,787, meaning you pay back your mortgage 6 years and 1 month earlier than you initially anticipated and saved $76,061.60 in interest over the life of the loan.
One of the beauties in the way loans work is that you have a repayment schedule that is set over 30 years, but you have the flexibility to make early repayments any time you like. And because the interest is calculated on the daily balance, the day you make that early repayment, you start saving money. That compounds over the life of the loan, in order to save you even more money.
Tim’s tip: “A good way to add a little more to your mortgage is to round up the amount you pay each month. If you’re monthly repayment is an odd number, like $3,467.80, for example, why not round your repayments up to $3,500 or even $4000 a month to get ahead. The extra few dollars will amount to big bucks over the course of a few years.”
How can I reduce the amount of interest I pay?
Another fundamental when it comes to repayments is to make them as early as possible, because every day counts. Mathematically, interest is calculated on the daily balance, meaning every lender does a calculation to say this person just accrued x amount of interest at the end of each day.
If you can minimise that balance on that day, you save on interest and, if you can do that every single day, you save interest on interest. So, things like making your repayment on the day that you get paid your salary is a very smart thing to do. It’s like managing your personal cash flow, the same way a business would manage its cash flow. Cash comes into your bank account and, if you can maximise the flow of that cash into your mortgage account, then you will save the most in interest.
This is a very effective way to pay your debt off sooner – if your interest is lower, then every repayment you make is paying more off the principal.
What type of loan should I opt for?
A variable interest rate loan is one in which the interest charged on your loan changes along with market rates changing. If the Reserve Bank decides to hike interest rates, your home loan rate will also increase, meaning your repayments will go up – and down, depending on the cash rate. A big advantage of variable rate loans is you can make extra repayments at no extra cost. (With fixed-rate loans, some lenders limit the extra repayments you can make.)
A fixed interest rate locks you into the same rate for a period of time, usually one year, three years or five years. It keeps your repayments the same during that time – even if the RBA moves the official cash rate up or down.
If rates are low, many people will opt to lock into a fixed rate, in order to keep their repayments low in case the interest rate rises. Alternatively, if rates are high and look like they will go down at some point, many people will choose a variable rate so that their repayments drop when the interest rate falls.
You can also choose to fix part of your rate – known as a split loan – which enables you to benefit from aspects of both types.
It’s worth asking your lender about extra features that come with your home loan. These could include the option to make extra repayments, the use of a redraw facility and/or an offset account. An offset and a redraw mathematically produce the same outcome, but they provide a different set of banking services. An offset is a fully transactional bank account that’s linked to your home loan, whereas a redraw facility enables you to pay down the balance,get ahead of your normal repayments schedule and redraw the extra repayments if and when you need the extra cash.
What’s the difference between a redraw facility and an offset account?
The difference between the two is a bit confusing – in fact, I had to ask our in-house expert the same question three times before I wrapped my head around it. But the difference is this:
Redraw facility: A redraw facility enables you to put any money you have saved towards making extra repayments. If you happen to need this money at any time, you can simply withdraw it. There may be fees involved, so it’s worth checking the details with your lender. It’s like a savings account for big ticket items. You may like to pay an extra $10,000 into your redraw facility and reduce the interest on your loan. But then redraw that $10,000 a year down the track to pay for a holiday. Or let’s say you choose to make 10 extra repayments of $200. The 10 months where you have made an extra payment has reduced the interest you are being charged during that 10 months. So even when you take it out at the end of the 10 months, the benefit of it having been there stays in the loan, because you have been charged less interest during that time. So every repayment that you make from that point onwards and into the future is paying off more of the principal and less of the interest.
Offset account: An offset account is more like a transaction account. You set it up to receive all your income and the bank then offsets the balance in your account against your loan balance. As a result, interest is only calculated on the remaining loan balance, which can save you a lot of money in the long term. It’s a good idea to set up your offset account to receive your salary payments and any other income you receive. You can access the money on a day-to-day basis, but the money that is in there will be offset against your mortgage so the more money you have, the better off you’ll be. An offset account usually has fees, but some lenders do offer no fee offset home loans.
An offset account and a redraw account can effectively give you the same result, but they are practically and conceptually different: Money you’ve put in a redraw account is technically a home loan repayment, and money in an offset account is technically savings that “offsets” the debt of your home loan to reduce the interest payable.
Tim’s tip: “Pay your bills on the day they are due, rather than the week before they are due, if the money is coming out of your redraw or offset facility.”
Leaving the money for an extra seven days in your account builds up more interest for you. Think about it as the optimal system to pay off a home loan and pay the least amount of interest. And it’s all set up using online banking and direct debits, so it’s not a difficult thing to do.
Talk to our team of home loan advisers about the options available and decide which option best suits you and your situation.
Can I still take a holiday while paying off a mortgage?
Many people wonder if they’ll ever be able to afford holiday again once they take out a mortgage. In fact, a great trick is actually to save up for a holiday by making extra repayments on your home loan. If your home loan has a redraw facility, you can build up a balance over time of, say $20,000, by making $20,000 worth of early repayments onto your home loan. This means less interest is charged to your home loan during this time.
When you want to go on holiday, you redraw the $20,000 and you have still benefited from the reduced interest charges while that money has been in the home loan account.
You could achieve the same thing if you saved that $20,000 in an offset account, but it’s more accessible that way – and potentially more tempting to spend day-to-day – so the redraw option might make it easier if you’re not as disciplined as you’d like to be.
The important thing at the end of it all is not to then spend $25,000 on your holiday!
Tim’s tip: “For some people, putting $10,000 into their mortgage as an extra repayment and redrawing for the holiday they are going on next year works best to prevent spending the money. So for them, the best thing is some way that takes it out of reach.”
For other types of people, they can keep that efficient cash flow management going. They work with that discipline. That’s an important part of the right solution and the right lender and the right products. How are you as a borrower, as a person, how do you best manage your financial affairs?
What other features should I look for in a loan?
There are some other important features you might want to consider when taking out a home loan. If you think you might sell the home you have the loan for, before you’ve paid it off, for example, you could consider a portable home loan.
A portable loan allows you to transfer your loan to your new home without paying discharge fees on your old loan and new fees on your new loan – which could total a few thousand dollars.
And while we’re on the topic of fees, it’s worth mentioning that many lenders won’t ask you to pay the fees upfront but will add them to your principal instead. As the principal increases, so does the interest you pay. Because of this, you should always pay the fees and charges up front, so you don’t pay more than you have to in interest.
What else can I do to save money?
To save more money and contribute more to your home loan, it’s important to organise your spending and create a personal finance plan. This will help you identify ongoing costs that perhaps you don’t need, such as pay TV subscriptions, a gym membership you never use, or a wasteful cigarette or coffee habit.
One of the first things many lenders suggest you do to save money is consolidate your debts. By paying off credit card loans, car loans or other personal loans, you’ll have less payments to worry about and can concentrate on putting all your money into your home loan.
But be honest with yourself about how much you can afford to repay. Unfortunately, too many people fall into the trap of underestimating their expenses, so take time to go through your expenses and be certain you’re capturing everything when you do your budget.
Should I be thinking about the future when I budget for repayments?
It’s not only important to consider your current lifestyle when working out the size of the loan you can afford, but things that might happen in the future too that are likely to impact your loan repayments.
Rising interest rates are one thing to consider. With our example above paying off a $500,00 loan with an interest rate of 4.00%, if the RBA increases the cash rate by 1%, your repayments will jump and you’ll pay an extra $297 a month over 30 years (see tables below). When taking out a mortgage, it’s worth estimating the cost of your repayments at a much higher rate than the current cash rate to ensure you can still make them if rates rise.
Aside from rising interest rates, if something happens to your health in 10 or 20 years time, you may be faced with medical costs that you hadn’t accounted for. If you plan to start a family, you should also consider the costs of children (dependents) and how your income will be affected if you or your partner choose to take some time off work.
Many people forget to factor in housing costs such as painting walls, or even the cost of furniture to fit-out their new home, when they take a home loan. It’s important to allow a buffer for these things. If you build up a redraw amount and something happens, you can make your repayments out of that buffer.
Consolidating your debt
As you probably know, interest rates can be quite unpredictable. If they go up, it will reflect on all types of credit you have and not just your home loan. In fact, home loans have much lower interest rates than your credit card or any personal loan you might have.
To combat the high interest rates, lenders will sometimes let you merge all your outstanding debt into your home loan. If you do this, you’ll be able to repay it at the interest rate that applies to your home loan. Rather than paying $2,000 a month on your mortgage and another $800 on your credit card bill and $200 on your car loan, by consolidating all that into one repayment it becomes much more convenient and simple to manage. Plus that one repayment won’t be 2000 + 800 + 200, but will be reduced as your credit card and car loan repayments will be stretched out over a longer loan term – the term of your home loan.
A great way to save money, however, would be to continue paying off the consolidated loan at the amount you are currently paying, and get it paid off quicker.
What can I do if I’m self-employed?
If you’re self-employed, you probably have to pay the goods and services tax (GST) every three months. But you can also take advantage of this to lower the interest on your home loan. All you need to do is take the money you’ve set aside for the GST payment and put it in your offset account.
For each day that money is in your offset account, the interest on your repayment will be calculated at a lower rate. When it’s time to pay the tax, you can just pay it straight from your offset account and repeat the process for the next quarter.
What if I have two or more properties?
People who own two properties they haven’t repaid in full can benefit from structuring their loan. For instance, they have a home they live in and another property they’ve invested in. Both are still subject to loans, which means they’re making repayments on both each month.
Servicing two loans at once means that you don’t really own either one of them. Seeing as you’re stuck making principal and interest repayments on both, you won’t be getting the title deed on one of them any time soon.
Many lenders will allow you to structure your loan so that you’re able to repay one property in full before you continue paying off the other one. Upon your request, one part of your loan will switch to interest only. You will only pay the interest until you pay off the home loan you took out for your home.
That means that the money you used to pay for both loans will go towards the principal and interest on one of them. Therefore, you will pay off your first property faster than you would if you hadn’t structured the loan. Once that’s done, the other part of your loan will revert to principal and interest until you’ve serviced it in full.
Tim’s Tip: “Have all rental income paid into the offset account linked to the home you live in, then pay bills for the rental property out of that offset account. This way the rental cash flow helps to reduce interest on the loan for the house you live-in.”
If you’re having trouble making your home loan repayments (and you can read more about mortgage stress here), speak to your lender about taking a repayment holiday. A repayment holiday allows consumers to take a break from repayments and can be used if you’ve lost your job, find yourself in financial strife, go on maternity leave or would like to go on an extended holiday, for example.
Depending on the lender, you may be able to take a repayment holiday for up to six or even 12 months.
Taking a repayment holiday allows you to consider options like refinancing to lower your monthly payments to assist you to get back on track. If you’re already in arrears (i.e. you’ve missed a home loan payment), it is difficult to find a lender who will refinance, therefore the repayment holiday is an important option should you find yourself in stress.
Tim’s tip: “It’s important for someone to be honest with themselves in terms of how much they can afford in repayments. Do a personal budget and work out how much you can comfortably afford. Allow for a bit of a buffer –things happen.”
This information is general in nature and you should always seek professional advice when making financial decisions.
uno’s repayment hacks
Hack #1 – Make weekly or fortnightly repayments if you can, rather than monthly. Going from a monthly to a weekly repayment schedule will help you pay off the loan faster and save on interest as you’ll make four extra repayments a year.
Hack #2 – Round up your repayment amounts. If your weekly repayment is $550, why not round the amount up to $600? The extra $50 per week could save you around $55,000 over the life of the loan. (On a fixed rate, you might be charged fees for making extra repayments).
Hack #3 – Set up an offset account. You can set up an offset account to receive your work income and any money you receive and your lender will offset the balance in your account against the balance of your home loan.
Hack #4 – Increase your payments with a pay rise or monetary gift. If a pay rise is on the cards, a bonus, or even birthday cash from a relative, consider putting the money toward your mortgage – rather than spend it on something you probably don’t need. You’ll reduce your principal and interest significantly.
Hack #5 – Pay the same amount on your mortgage – even if interest rates drop. When interest rates drop and you’re on a variable rate, it could be tempting to pay less on your home loan repayments. But it’s better to keep paying the same amount and pay off your debt faster.
Hannah Tattersall worked as a journalist in Sydney, New York and Edinburgh before joining uno as its Content Editor. She has written for The Australian Financial Review, The Sydney Morning Herald, Qantas The Australian Way and In The Black, among other titles, and worked for 21st Century Fox and News Corp. She writes content aimed at buyers, investors, refinancers and anyone interested in the home loan process and welcomes feedback on how we can make uno's content better for you.