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One of the most common questions homebuyers ask their mortgage broker is: “What is the lowest interest rate out there?”
And while it’s a valid inquiry, it may not be the right question.
Focusing solely on securing the lowest possible interest rate can sometimes lead you astray – a rate that is considered good on paper might not actually align with your financial goals or situation. Also, interest rates across home loans can vary a lot and for many reasons, so a good interest rate for you may not be great for someone else.
Rather than fixating on what constitutes a “good” interest rate, a more impactful question might be: “Do I have the best financial strategy for my unique circumstances?”
Let’s dive deeper into why this is the case.
Why are interest rates such a big deal?
Interest rates are important to your home loan calculations because they affect the total cost of your loan over the life of the mortgage and therefore the cost of the repayments you make each month.
You’re expected to pay back not only the amount you borrowed (called the principal), but also the interest stipulated in the loan terms.
Take this scenario: You borrow $500,000, and your broker finds you the lowest interest rate possible, at say 5%. You might be stoked! However, the particular home loan doesn’t allow you the flexibility to make extra-repayments, or doesn’t allow you to have an offset account, or has ongoing-yearly fees, exit fees and other costs associated.
These might seem small at the outset, but over the life of a loan, could wind up costing you more than if you take out a loan at a slightly higher interest rate, but one that has the features and flexibility you need.
Obviously, the higher the interest rate charged for your loan, the more you’ll pay. So, of course, we all want a loan with a lower interest rate. However, beyond that basic truth lies the real life complexities of the home loan world.
How is the interest rate on a home loan calculated?
Interest rate options vary from lender to lender, however, there are a number of factors that they’ll use to determine which interest rates they are prepared to offer you.
These factors can include:
- Loan purpose – is it an investment property or will it be owner occupied?
- Repayment type – will you repay principal and interest or interest only?
- Rate type – will you go for a fixed or variable rate?
- Product type – does your lender have options, or ‘discounted’ loan types?
- Loan features – will the loan have an offset account or other features that work for you?
- LVR – do you have a lower LVR affording you a lower interest rate for your home loan?
- Serviceability – how easily can you meet repayments?
- Loan length – are you agreeing to a 30 year loan or shorter?
- Repayment frequency – how often will you make a payment?
The Bigger Picture: Financial Goals and Flexibility
Beyond interest rates, it’s crucial to align your loan terms with your broader financial goals. Here are some considerations that should discuss with your mortgage broker in your quest for the “best” rate:
Total Loan Costs – Sometimes a lower interest rate comes with higher fees. Always calculate the total cost of the loan over its entire term, including any origination fees, prepayment penalties, or other hidden costs.
Flexibility and Terms – A slightly higher interest rate on a loan with flexible payment terms might be more beneficial than a rigid loan with an ostensibly lower rate. Flexibility can provide a cushion during financial hiccups, giving you peace of mind.
Opportunity Cost – Weigh the opportunity cost of securing a lower rate. For instance, if waiting to improve your credit score for a better rate keeps you from investing in a property whose value is rapidly appreciating, the delay could cost you more in lost equity than you save with a lower interest rate.
Personal Financial Health – Assess whether taking a loan will strain your finances or fit comfortably within your budget. Sometimes, avoiding debt altogether—even if you qualify for a lower rate—might be the best decision for your fiscal well-being.
How to get the best rate?
What can you do to ensure you get the best rate for your financial situation and property goals?
Strategies to negotiate or qualify for lower interest rates will vary depending on your individual circumstances but the more informed your decision the lower your chance of your chosen interest rate costing you big in the long run.
Some important steps to getting the best rate for your unique situation might include:
- Check out comparison fees – these give you a clearer idea of the true cost of the loan than the advertised interest rate, including the interest rate, upfront fees, ongoing fees and discharge fees.
- Look past the advertised rates – they do not apply to everyone.
- Be clear about any loan features – does the loan have the features you need or will it lock you in to choices you don’t want to make further down the track?
- Consider the long term implications – it’s hard to look years and even decades ahead but keeping the long term life of the loan in mind from the start can save you big time.
- Shop around – explore multiple lenders and consider alternative loan options. There’s a lot out there.
- Seek professional advice – it pays to have the professionals working with you to ensure you don’t miss a beat and get the best rate option for you.
Refinancing: An Ever-Evolving Equation
For those considering refinancing, the principles remain the same but with added complexity. Refinancing can lower your interest rate and monthly payments, but also involves costs and potential risks. The key questions to evaluate include:
- Break-Even Point: How long will it take for the savings from a lower interest rate to cover the costs of refinancing?
- Loan Term: Will refinancing extend your loan term and thus increase the total interest paid over time?
- Financial Stability: Are your finances stable enough to handle potential fluctuations in interest rates if you opt for a variable-rate loan?
Play the Long Game
A “good” interest rate is one that aligns with your financial plan and objectives. It requires a holistic approach, taking into account your current financial health and future goals.
So, remember to keep in mind that the best interest rate isn’t just about numbers; it’s about finding a rate that fits seamlessly into your overall financial strategy.
Before making a decision, take a step back, assess your unique situation, and ask the right questions. In doing so, you’ll be well on your way to making informed, strategic financial choices that support long-term wealth and stability.
