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What influences the interest rate on my home loan?

The ebb and flow of interest rates explained

Taking out a mortgage is one of the biggest financial commitments you can make, and interest rates significantly impact on the long-term cost of your home loan. Even the smallest change can mean paying thousands of dollars more or less over the term of the loan. 

Interest rates move up and down regularly – what you can get from one lender might be higher or lower compared to another. This can make it quite challenging – especially for first-home buyers – to get a gauge on whether the interest rate being offered is reasonable or not.

But why is that? Interest rates are influenced by economic factors and government policy, as well as the financial health of potential borrowers. This article outlines some of the factors that influence Bluestone’s interest rates.

Bluestone’s funding structure

The first crucial aspect to understand is that lenders must borrow the money they lend to you. The cost of those funds is constantly fluctuating because of global economic conditions and geopolitical events directly impacting on the interest rate passed down to borrowers. 

At Bluestone, we negotiate with major banks to establish warehouse funding facilities. Think of a warehouse funding facility as a giant overdraft, and with each loan we settle we draw out the money to pay you. 

Once the warehouse gets close to capacity, and there are no more funds available, we package all the loans up as a pool of assets. They are taken out to the capital market to sell as interest-bearing bonds. 

That process is called securitisation, meaning Bluestone pays investors an agreed amount of interest based on how much they invest. When a pool of assets has been secured by investor purchases, it comes out of the warehouse funding facility, and we start the whole process again.

The cash rate target

You’ve probably heard about the cash rate target, also known as the reserve rate, that can affect home loan interest rates. But the reserve rate is only one cog in the big wheel that is the global financial market.

The cash rate target is set by the Reserve Bank of Australia to help manage inflation and economic activity. Generally, the higher the cash rate the more attractive it is to save money, and the lower it is the more attractive it is to borrow and spend. Therefore, as the reserve rate moves up or down so might home loan rates – but not always, and not necessarily by the same amount. 

Our funding is effectively pegged by what is called the Bank Bill Swap Rate. This is the rate at which banks lend to each other. That rate changes every day, and it’s set based on the forward expectations of the cash rate target. So, while our rates are not directly affected by the cash rate, it is one influential driver.

The level of risk

Unlike bank lenders who take a tick-the-box approach to home loan assessments, at Bluestone we have a range of loan options. This means we’re generally able to find a home loan product to suit a very wide range of borrowers – but the interest rates will vary from customer to customer. 

That’s because individual risk factors influence the interest rate you pay. These risk factors won’t necessarily disqualify you from getting a home loan, but the extra risk may increase your interest rate. 

Risk factors include:

  • Higher loan-to-value (LVR) ratio. The LVR is about how much of your own money you’re putting into a property compared with how much you’re borrowing. The lowest interest rates are for people looking to borrow under 60% of the property’s value. Bluestone’s rates increase every 5% above that. A higher LVR is riskier, because it means your loan is more vulnerable to market fluctuations. For example, if you buy your home at a 90% LVR, the property market would only need to drop 10% for you to drop into negative equity – meaning you owe more money on your property than it is worth. At 60% LVR, the market would have to drop 40% for this to happen, which is far less likely to happen, and thus less risky for both you and Bluestone.
  • Full doc versus alt doc. Self-employed borrowers may want to take advantage of alternative documentation, or alt doc loans. Alt doc loans offer the option to prove self-employed income with BAS statements or business bank statements, rather than more comprehensive tax records. This can be the best option for a borrower for many reasons, but the more comprehensive our understanding of your ongoing income is, the less risk we are taking on to lend to you – so alt doc interest rates are a little bit higher. You can read more about full doc versus alt doc loans here.
  • Credit file. Your credit file is a record that reflects your credit history, including any credit enquiries as well as any judgements and defaults. Your credit file is one measure we will assess when we look at your situation, but we also seek to understand the nature and context of any arrears or defaults you had. So just because you may have had a blip in the past does not automatically mean you will be locked out of competitive interest rates.
  • Previous conduct. In the past, if you’ve struggled to pay back debt on time or you’ve defaulted on a loan, you may find this drives your interest rate higher.

But wait, here’s the good news

Lower your risk, get reassessed

Far too often, people will set and forget their home loan. But even though you’ve signed a 30-year term, interest rates are constantly moving, which means it could be worth being reassessed, every 12 months or so. This could bring your interest rate down if you’ve done things like paid off debt, got your income documentation in order or can now demonstrate good conduct. At Bluestone, you are entitled to request an annual rate review, provided your conduct has been clear.

Stay informed, lower your risk

At the end of the day, it’s a combination of factors that determine what your home loan interest rate will be. Every borrower’s financial situation is different, and while there’s not much you can do to change the global financial market in your favour, there are plenty of other factors that will influence your home loan interest rate.

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