Interest is a major cost to factor into your home loan decisions. When repaying your home loan, not only do you have to repay the principal (loan amount) each month, but you also have to pay the interest charged on top of your balance.
Most borrowers have a loan term between 20 and 30 years. Even though home loan interest rates tend to be low, in comparison to credit cards and car loans, the total interest does add up over this time.
For example, on a 25 year $300,000 mortgage with a 3% interest rate, you’ll pay about $126,790 in interest. That is a lot to spend on interest alone!
This is why it’s important to jump on opportunities to save money and reduce your interest rate. In this article we’ll explain how interest is calculated, tell you how to pay less home loan interest, and show you how much you could save with a lower rate.
How is interest calculated on a home loan?
Unfortunately, banks aren’t in the business of lending money for free. They have a number of costs to cover and also want to make a profit, so they charge interest on top of the loans they provide. Think of interest as a percentage-based borrowing fee because you are using someone else’s money.
Interest is calculated from the daily closing balance of your loan and is only accrued from your loan amount at the time. This is why making principal and interest repayments, and making extra repayments (if possible) can be very helpful. The lower your loan balance, the less interest you will be charged.
Getting a good interest rate is critical for borrowers wishing to minimise their interest payments. Even a marginal 0.5% interest rate reduction can make a significant difference in the long term.
For example, if you get a 30 year $400,000 home loan with a 3% interest rate, you’d pay an approximate total of $207,109 in interest. With a 2.5% interest rate, you’d pay about $168,974 in interest over the life of the same loan.
Of course, it’s highly unlikely that you’ll have the same interest rate over a 30 year time period. Most fixed rate home loans only guarantee an interest rate for up to 5 years and variable interest rates are popular among borrowers for their flexibility.
How much interest do you pay on a $1,000,000 home loan?
As your loan size increases so does the total amount of interest you’ll pay over your full loan term. You can see here that borrowers with a $1,000,000 loan amount could pay more than $800k in interest if they’re not always on a competitive rate. That means paying over 80% of the total loan size again to your bank.
Amount borrowed | Interest rate | Loan term | Monthly repayment | Total interest paid over life of loan |
$1,000,000 | 2.5% | 30 | $3,951 | $422,360 |
$1,000,000 | 3.5% | 30 | $4,490 | $616,400 |
$1,000,000 | 4.5% | 30 | $5,067 | $824,120 |
How much interest do you pay on a $800,000 home loan?
As your loan size increases so does the total amount of interest you’ll pay over your full loan term. You can see here that borrowers with an $800,000 loan amount could pay more than $650k in interest if they’re not always on a competitive rate. That means paying over 80% of the total loan size again to your bank.
Amount borrowed | Interest rate | Loan term | Monthly repayment | Total interest paid over life of loan |
$800,000 | 2.5% | 30 | $3,161 | $337,960 |
$800,000 | 3.5% | 30 | $3,592 | $493,120 |
$800,000 | 4.5% | 30 | $4,053 | $659,080 |
How much interest do you pay on a $550,000 home loan?
As your loan size increases so does the total amount of interest you’ll pay over your full loan term. You can see here that borrowers with a $550,000 loan amount could pay more than $450k in interest if they’re not always on a competitive rate. That means paying over 80% of the total loan size again to your bank.
Amount borrowed | Interest rate | Loan term | Monthly repayment | Total interest paid over life of loan |
$550,000 | 2.5% | 30 | $2,173 | $232,280 |
$550,000 | 3.5% | 30 | $2,470 | $339,200 |
$550,000 | 4.5% | 30 | $2,787 | $453,320 |
How to pay less home loan interest
Your home loan is already a major expense, so don’t pay more in interest than you have to. Here are 5 ways to pay less interest on your mortgage:
1. Ask your lender for a lower interest rate
Refinancing isn’t the only way to seek out a lower interest rate. Usually, you can start by simply asking your lender to lower your rate. Research and find out what rates your lender is offering to new customers. If it’s lower than what you’re paying, it’s worth asking for a better deal.
Your chances of getting a reduced rate will depend on your risk to the lender. If you have a history of making on-time repayments and have a good credit score, you’ll likely be perceived as lower risk.
Read more about negotiating a lower home loan rate.
2. Refinance
Most borrowers should look into refinancing every two years or so. Not only does refinancing ensure that you have a home loan that suits your up-to-date needs and financial situation, but it can also give you the opportunity to secure a lower interest rate.
Don’t be afraid to consider a range of lenders as there may be more competitive home loan deals out there.
3. Get an offset account
An offset account can be a great way for savvy savers to reduce their home loan interest. It is a kind of savings account linked to your home loan balance designed to help you pay less interest. Any funds in this account offset how much interest you are charged. For example, if you have a $200,000 home loan with $20,000 in an offset account, you’ll only be charged interest on $180,000.
Compare offset accounts with redraw facilities here to see what is best for you.
4. Make extra repayments
Making extra repayments on top of your monthly repayments reduces your home loan balance even further. It can also help you pay off your loan faster. The shorter your loan term and the lower your mortgage, the less interest you’ll be charged.
If you have a fixed rate home loan, be sure to check your loan terms or contact your lender to ensure that you can make extra repayments without penalty. Many fixed rate loans attract break fees when you make additional repayments or repay your loan early.
5. Avoid interest only home loans
If paying less home loan interest is a priority for you, then you’ll probably want to avoid interest only repayments. Instead, opt for a traditional principal and interest repayment system where you pay down the principal (loan balance), in addition to the interest charged on your loan.
An interest only home loan means that you aren’t paying off the principal (loan amount) for a set period of time. When the interest only period ends, you’ll be faced with larger monthly repayments including both interest and principal.
How much can you save by reducing your interest rate?
Getting a lower interest rate is one of the best ways to reduce your monthly repayments and spend less on your home loan overall. See the table below for an indication of how much interest you’ll pay on a home loan with different interest rates:
Amount borrowed | Interest rate | Loan term | Monthly repayment | Total interest paid over life of loan |
$500,000 | 2.8% | 25 | $2,319 | $195,812 |
$500,000 | 2.4% | 25 | $2,218 | $165,396 |
$500,000 | 2.0% | 25 | $2,119 | $135,782 |
What might seem like an insignificant saving in the short term can amount to big savings long term. Read our article on determining whether it is worth refinancing for more information.
