# How does a bank charge interest on your home loan?

Interest rates are one of the biggest costs associated with a home loan, so you may be curious to know exactly how interest is calculated and charged.

Fortunately, there are mortgage repayment calculators available to do the math for you. But some homeowners and potential buyers may want to know exactly how a lender calculates interest on home loans and how to do those calculations yourself.

### How to Calculate Interest on Home Loans

Interest on a home loan is calculated daily by multiplying your loan balance by your interest rate (as a decimal) and dividing it by 365 (366 in a leap year).

Your monthly interest charge is calculated by multiplying your daily interest amount by the number of days in that month. The amount of interest payable may vary depending on your interest rate and the number of days in the month. So if interest rates were to rise or it was a longer month, your repayments would be higher that month.

For example, on a \$500,000 home loan with an interest rate of 2.5%, you would calculate the daily interest rate using the following formula:

• (\$500,000 x 0.025) ÷ 365 =\$34.25

Then, to determine your weekly, semi-weekly, or monthly interest charges, simply multiply the figure above by the number of days in that payment cycle.

• Weekly repayments: \$34.25 x 7 = \$239.73
• Semi-weekly repayments: \$34.25 x 14 = \$479.45
• Monthly repayments: \$34.25 x 30 = \$1,027.40

Unless you are only paying the interest, you will also have to pay the principal due on your mortgage. The calculations above are just the interest charges for your repayments over a specific period of time.

### How to reduce the amount of interest charged on your mortgage

As mentioned above, interest is one of the biggest costs you will face when paying off a mortgage. Depending on your financial situation and budget, it may be worth considering strategies to reduce your interest costs and mortgage payments, including:

A clearing account is a home loan feature offered by some lenders, usually for variable rate home loans. It acts as a linked transaction account and by depositing funds into your clearing account it helps to “offset” or reduce the amount you pay in interest.

For example, on the same \$500,000 home loan, if the homeowner deposited \$30,000 in their offset account, their interest charges would be calculated as if the mortgage was only \$470,000.

This would make the home loan calculations:

• (\$470,000 x 0.025) ÷ 365 =\$32.19
• New monthly interest = \$965.73
• Previous monthly interest charges = \$1,027.40

If you’ve been paying off your home loan for a while, you might want to jump online and see what interest rates your lender is offering new customers. Chances are they’ll be much less than what you pay, as lenders typically offer lower rates to bring new customers to their books.

The last Reserve Bank of Australia data at time of writing shows that for the average customer of an owner-occupied variable mortgage, new customers pay rates of 2.52% and existing customers pay 2.94%. This means that new customers get a 42 basis point discount just for being new customers.

To help lower your interest rate, it may help to pick up the phone and simply ask your lender for a better rate. Mention that you have seen that they offer lower rates for new customers. You’d be surprised what you could get if you asked.

• Refinance at a lower rate

If you’ve built up some equity in your mortgage and aren’t happy with your current interest rate, you might consider researching and refinancing your home loan with a lower-rate lender. .

Use comparison tools, like RateCity’s Low Rate Home Loan Chart, to filter and view competitive options that might be a better fit for your financial situation. You can even use this research as ammunition if you call your lender and try to negotiate a better home loan rate. If they don’t budge, it may be worth calculating the costs of switching and determining whether refinancing at a lower rate may be the best decision.