Why is my Interest Rate so high?

Well 2024 is well underway, and there is a welcome and increasing optimism that interest rate cuts could be on the horizon. The last two years have been brutal for mortgage customers. And we are potentially at the peak of the interest rate cycle, if not we are at least close. But I wouldn’t get too excited just yet, I don’t see Interest rates falling through the floor at the speed they raised through the roof. So, what I wanted to do was share with you some important factors that will help you understand why you get charged what you do.

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Firstly, there are a number of factors that determines the “risk” the bank is taking to make the loan out to you for your home.

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The most common are:

1.      The value of your home vs the amount you are seeking to borrow. This is referred to as “Loan to Value Ratio” (LVR) or popular in other countries, Loan to Value (LTV).  The lower the better.

2.      How your Income compares to the amount of money you are borrowing “Debt to Income” Ratio.

3.      If you are an Owner Occupier or Investor. Rates for Owner Occupiers are a bit cheaper

4.      If you are asking to pay Interest Only or Principal and Interest

So what we are going to do here is cover off on why your interest rate might not be as low as your mates.

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Loan to Value Ratio: Wtf is that?

Let’s say your home is worth $650,000, and you need to borrow about $500,000 to refinance, then this means you are borrowing 77% of your home value from the bank. So There is going to be 23% equity in the home leaving plenty of room for the bank to protect its risk.

Even if you defaulted on your home loan and skipped the country, the bank will still have plenty of time to repossess, sell and recover their funds.

But they will not give you the BEST pricing for your home loan, as there is only 23% equity. Imagine if there was 50% equity, or 40%equity. The bank has nothing to worry about, that is why they give those clients their best possible interest rates.

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Debt to Income Ratio: Come on mate.

So this one sits more in the background, you are unlikely going to get pulled up on this one unless you are borrowing way too much for your income. It is essentially a rule introduced by APRA whereby they want banks to monitor and measure a customers “Debt to Income” (DTI) ratio and ensure this remains sensible.

Say Mr. Smith is earning $75,000 and, Mrs. Smith is also earning $75,000, they are on a total of $150,000 combined. Yet they wanted to borrow $850,000, and they also had a car loan for $65,000. Then they are asking the bank to give them 6.10x their total income. This is something that a lot of banks will actually want them to have more than 20% equity (remember how we work that out from earlier). If they have less than 20% equity, it leaves two areas of risk to worry about and some banks will walk away.

Owner Occupiers get Charged less than Investors. Why exactly?

This one is a little more straight forward, if you were someone who liked to have a punt, and you were asked to bet on who is more likely to pay their mortgage, an investor, or someone who lives in the house themselves more often than not with their family.

It is pretty clear that the historical data supports the fact family will sacrifice nearly every other pleasure in life before missing a mortgage repayment. This mentality in Australia has held our property and banking markets together many times in history. Even when our parents would be losing it about paying 20% interest rates, they rarely lose it about falling behind on their mortgage. They made it work. They just couldn’t upgrade the VL to the new VP.