What Determines the Interest You Pay on Your Home Loan?

Home loan interest is calculated based on the outstanding loan balance and the interest rate applied by your lender. The most common method used by Australian lenders is daily interest calculation, which means that interest is charged daily on the remaining balance and compounded monthly.

Formula for Daily Interest Calculation

The formula used to calculate your daily interest is:

(Loan Balance x Interest Rate) / 365 = Daily Interest Charge

For example, if you have a $500,000 loan with an interest rate of 6.00% per annum:

(500,000 x 6.00%) / 365 = $82.19 per day

This daily interest charge is then accumulated and added to your loan balance each month.

Does Your Repayment Frequency Affect the Interest Paid?

Yes! Your repayment frequency plays a role in reducing the total interest you pay over the life of the loan. Lenders typically allow repayments on a weekly, fortnightly, or monthly basis. Since interest is calculated daily, making repayments more frequently reduces the principal faster, leading to lower interest charges. 

Example: The Impact of Repayment Frequency on a $500,000 Loan Over 30 Years at 6.00%

• Monthly repayments: $2,997 per month

• Fortnightly repayments: $1,498 per fortnight

• Weekly repayments: $749 per week

While it may seem that these amounts are equivalent, fortnightly and weekly repayments lead to lower interest payments over time. This is because there are 26 fortnights in a year, meaning you make the equivalent of 13 months of repayments instead of 12. This small change can shave years off your loan and reduce your overall interest costs.

TOP TIP: if you're making your repayments from an offset account your interest is being reduced on a daily basis. Therefore it won't matter what frequency you pay.

How an Offset Account Helps Reduce Your Interest Charges

An offset account is a transaction account linked to your home loan. Instead of earning interest on your balance, the funds in your offset account are deducted from your outstanding loan amount before interest is calculated.

Example: The Impact of an Offset Account on a $500,000 Loan

• Without an Offset Account:

  • Loan Balance: $500,000

  • Interest at 6.00% = $82.19 per day

    
    

• With a $50,000 Offset Account Balance:

  • Effective Loan Balance: $450,000

  • Interest at 6.00% = $73.97 per day

By reducing the amount on which interest is calculated, an offset account helps you pay off your loan faster.  

Why Do Some Months Have Higher or Lower Interest Charges?

Since interest is calculated daily but charged monthly, the total interest charged each month can vary. Months with more days (such as January with 31 days) will have a higher interest charge compared to shorter months (such as February with 28 or 29 days).

For example:

• A loan balance of $500,000 at 6.00% interest will accrue $82.19 per day.

• In a 31-day month: $82.19 x 31 = $2,548 interest charged.

• In a 30-day month: $82.19 x 30 = $2,466 interest charged.

• In February (28 days): $82.19 x 28 = $2,301 interest charged.

This variation explains why your interest charges fluctuate slightly each month.

What’s the Best Strategy to Minimise Home Loan Interest?

To reduce the total interest you pay on your home loan, consider these strategies:

1. Increase Repayment Frequency: Switching to weekly or fortnightly repayments can help reduce interest charges.

2. Use an Offset Account: Keeping funds in an offset account lowers your loan balance and minimises interest.

3. Make Extra Repayments: Paying more than the minimum required amount can significantly reduce the total interest paid.

4. Compare Interest Rates Regularly: Refinancing your home loan to a lower interest rate can save thousands over time.

Final Thoughts: Make Your Home Loan Work for You

Understanding how home loan interest is calculated and making strategic changes to your repayment structure can save you a significant amount over the life of your mortgage. At Mortgage Matrix, we help borrowers find the best home loan solutions tailored to their financial goals.

Want to see how much you could save? Book a free appointment with one of our expert mortgage brokers today!