Interest rates first home buyer guide

Interest rates first home buyer questions almost always come back to one thing: rates are not set by your lender alone. They begin with the Reserve Bank of Australia (RBA), flow through to the rates banks charge, and land on your repayments. In short, your interest rate is the price of borrowing, and even a small change in it can make a big difference to what your first home costs over time. You cannot control the rate the market offers, but you can understand how interest rates affect a home loan, and you can choose a loan that suits your circumstances and budget.

This guide explains, in plain terms, where rates come from, how interest rates affect your home loan repayments, what rate rises mean for a first home buyer, and how to compare loans on more than the headline number.

If you are just starting out, the full picture sits on our first home buyer guide, and the deposit, scheme and lender decisions come together on the first home buyers hub.

Where your interest rate starts: the RBA cash rate

The starting point for interest rates in Australia is the cash rate. The cash rate is the interest rate on overnight loans between banks, and the RBA sets a target for it, known as the cash rate target. The RBA uses an inflation targeting framework that aims to keep consumer price inflation between 2 and 3 per cent, and it moves the cash rate up or down to help meet that goal.

The cash rate matters to you because it does not stay inside the banking system. The RBA explains that monetary policy has a strong influence over interest rates in the economy, including the lending and deposit rates faced by households and businesses. When the cash rate moves, the rate on your home loan can move too.

The link runs through the banks, and it helps to see it as a chain.

In short, the cash rate has an important role in determining the interest rates on banks’ funding sources, and banks measure the profitability of lending as the difference between the revenue they expect from making loans and the cost of funding those loans. So when their funding costs change, the lending rates they charge can change as well.

How interest rates affect your home loan repayments

The most direct way interest rates affect a first home buyer is through the monthly repayment. Your repayment is driven by three things: the loan amount, the interest rate, and the loan term. Hold the loan amount and term steady, and a higher interest rate means a higher repayment. A lower interest rate means a lower one.

MoneySmart puts it plainly: small differences in your mortgage interest rate can make a big difference to the long-term cost of your home loan. That is because interest is charged on the balance you still owe, month after month, often over 25 or 30 years. A rate that looks only slightly higher can add up to a large amount across the life of the loan.

The clearest way to see this for your own numbers is to model it. The free MoneySmart mortgage calculator estimates repayments from the loan amount, the interest rate, the loan term and the repayment frequency, and it lets you explore the effect of a higher or lower interest rate on your repayments. Trying a rate half a per cent higher, then half a per cent lower, shows you how sensitive your budget is before you commit.

Try the repayments calculator

You can use a repayments calculator to see how different interest rates change what you would pay each month.

What rate rises mean for a first home buyer

A rate rise is simply the interest rate on your loan going up, usually after the RBA lifts the cash rate and lenders follow. For a first home buyer, a rate rise matters in two ways.

First, if you already have a variable rate loan, your repayments can go up when rates rise. Second, before you buy, higher rates can reduce how much a lender will let you borrow, because lenders test whether you could still afford repayments if rates were higher.

You can build in a buffer for this. MoneySmart guidance is to be realistic about what you can afford and, to give yourself some breathing room, to work out what your costs would be if interest rates went up by 2 per cent. If your budget still holds at that higher rate, a future rate rise is far less likely to catch you out. This is sensible planning rather than a prediction, and what is right for you depends on your circumstances and lender criteria.

A pre-approval shows you the borrowing figure lenders are working with at current rates, which is why it is worth getting early. You can read how it works in our guide to home loan pre-approval for first home buyers.

Fixed or variable: the rate choice you control

You cannot set the market rate, but you can choose how your rate behaves. This is the fixed versus variable decision, and it is one of the main ways a first home buyer manages interest rate risk.

A fixed interest rate stays the same for a set period, for example five years. A variable interest rate can go up or down as the lending market changes. Each has trade-offs, and the right choice depends on your circumstances and lender criteria rather than a single rule.

Some first home buyers split their loan, fixing part and leaving part variable, to balance certainty and flexibility. Whether a fixed, variable or split structure suits you depends on your goals, your budget and lender criteria.

Compare the comparison rate, not just the advertised rate

When you start comparing loans, the headline interest rate is not the full story. Two rates matter, and they are different.

The advertised interest rate is the rate a lender promotes. The comparison rate is a single figure of the cost of the loan that includes the interest rate and most fees. Because it folds in fees, the comparison rate gives you a more complete view of what a loan may actually cost, which helps when one loan has a low advertised rate but higher fees.

It is also worth knowing how you repay. With a principal and interest loan you make regular repayments on the amount borrowed plus you pay interest, so the balance falls over time. With an interest-only loan the early repayments cover only the interest and the debt is not reduced during that period. Most first home buyers use principal and interest, because it steadily pays the loan down.

Interest rates first home buyer checklist: bringing it together

Interest rates for a first home buyer run from the RBA cash rate, through the banks, to your repayment. You cannot control where the market sits, but you can control the things around it: how much you borrow, the loan term, whether your rate is fixed or variable, and whether you compare loans on the comparison rate rather than the advertised rate alone. Building in a buffer for higher rates, and modelling your repayments before you commit, puts you in a stronger position whichever way rates move.

If a smaller deposit is part of your plan, the rate and the deposit interact, and our guide on buying with a 5 per cent deposit walks through how a low-deposit purchase fits alongside the rate decision.

Talk it through

Interest rates touch every part of your first home loan, and they change. If you would like a clear view of how current rates affect what you could borrow and repay, and which loan structure suits your circumstances across a range of lenders, the team at Finance Lab can walk you through it.

Frequently asked questions