[Video] How Is Home Loan Interest Calculated?
In Australia, home loan interest is calculated daily based on (Home Loan Balance – Offset Account Balance) x Interest Rate/365 … even in leap years!
The bank will add together the daily interest charges for each day and charge it once a month.
E.g. June’s interest will be based on 30 days, July’s interest will be based 31 days, and so on. Hence July’s interest charges will be higher due to the extra day.
A Worked Example
Let’s say we are calculating the repayment for July with its 31 days.
| Loan balance | $ 500,000.00 |
| Offset balance | $ 10,000.00 |
| Interest | 6.50 % |
| Day 1 interest | $87.26 |
| Day 2 interest | $87.26 |
| x31 days | … |
| That month interest total is: | $2,705.07 |
| Principal and interest minimum repayment: | $3,161.00 |
The account statement will then look similar to the table below.
| Date | Description | Debit | Credit | Balance |
|---|---|---|---|---|
| 01/07/2024 | Opening Balance | 500,000.00 | ||
| 01/08/2024 | Loan Repayment | 3,161.00 | 496,839.00 | |
| 01/08/2024 | Interest | 2,705.07 | 499,544.07 |
At the end of the month, the loan balance goes down by $455.93
Principal and Interest Home Loans
In the above example, regardless how much money you have in the offset account, the monthly repayment is the same i.e. $3,161.00.
However, if you have more money in the offset account, the interest charges will be less and more of your repayments will go towards the principal, hence you will reduce/pay off your loan sooner.
Interest Only Home Loans
An Interest-Only Home Loan allows you to initially pay only the Interest on the loan, rather than paying both Principal and Interest.
Interest Only period is typically available between 1-15 years depending on the Lender.
If you have 5 years Interest Only, then the Principal & Interest term will start after the Interest Only period ends, and it will last for 25 years typically.
Alternatively, you have to renegotiate or restructure the loan to have the interest only period reset.
If you have a Variable-Interest Only loan and you would like to make a ‘Principal’ reduction, you can usually do so by transferring the money directly into the home loan account.
After Interest Only Period, in this example, Principal & Interest Monthly repayment will be $3,377.00 per month. After the Interest Only Period ends, the Principal and Interest repayment is higher than the above because in this case you have 25 years to pay off your Principal (since the first 5 years were interest only).
Note that if you choose to have Interest only repayment, the interest rate will be HIGHER than if you choose to pay Principal and Interest.
