Research Note 15 1997-98

Home Loans

Size, Interest and Repayments

Stephen Barber
Statistics Group
24 November 1997

The monetary arm of government policy has been operating to decrease interest rates in an attempt to inject some impetus into a sluggish economy.

Continuing low inflation and small wage rises have seen official interest rates cut five times in the last 16 months - for a total reduction of 2.5 percentage points - down to 5.0% p.a.

Changes in official interest rates flow through into the other interest rates in the financial sector, with particular attention (as always) focussing on home loans. This note looks at the size, the interest rates and the repayments of home loans.

Loan Size

According to the June quarter 1997 joint Real Estate Institute of Australia and Citibank Ltd Home Loan Affordability survey, the average size of new loans in Australia was $114 400. Table 1 shows the average size of new loans issued by all major lenders (bank and non-bank) in each of the States and Territories.

Table 1: Size of Loans

Loan Repayments

Table 2 shows the monthly repayments that are payable on various size loans at different rates of interest, assuming a 25 year term and interest calculated monthly.

Table 2: Loan Repayments

The current (predominant) banks' interest rates for home loans (reported by the Reserve Bank of Australia [RBA]) is 6.70% p.a. Therefore, the monthly repayment on a loan with a principal of a $100 000 at this interest rate is approximately $690.

The table can also be used to calculate repayments for loan sizes other than those shown e.g. a loan of $52 000 at 7.00% p.a. over 25 years gives monthly repayments of $368 (= $7.07 x 52).

The current economic conditions - low inflation but a higher than expected wages growth figures and the possible ramifications of the South East Asian financial crisis - point to no rate decreases in the short-term. However, there should be no rises in the short-term either as the forecast rate for underlying inflation is still at the lower end of the RBA's 2-3% p.a. target range.

Loan Repayment Progression

The impression whenever a new loan is taken out is that the early repayments only seem to be just repaying the interest without appearing to be making any worthwhile erosion of the principal, i.e. the amount borrowed. The situation seems to suggest that the loan will never be paid out.

Table 3 demonstrates that this first impression is partially correct. The early repayments are predominantly paying back the interest but the loan is eventually repaid on time.

Table 3: Home Loan Repayments Progression

The example in Table 3 is for a loan with a principal of $100 000, a term of 25 years and an interest rate of 7% p.a. (approximately the current bank home loan interest rate). For simplifying the table layout, repayments are made annually and interest is also calculated annually. (Over the full term of the loan, the total amount repaid is $214 500).

In the early years a large proportion of each repayment goes to paying the interest and the remainder to reducing the principal, but as time goes on there is an exponential decrease in the proportion paid in interest and a corresponding increase in the proportion paid off the principal.

Chart 1 shows the trends of repayments of interest at 5%, 7% and 10% interest rates. (The values for the 7% line can be found in Table 3).

Chart 1. Proportion of Each Year's Repayment Paying Interest

The results regarding what proportions are paid off will vary with the interest rate. The higher the interest rate the higher the proportion paid on interest in the early years and the more years before more of the repayment goes towards the principal.

The crossover point, where more than 50% of the repayment is paid off the principal, occurs at the 12^th year for a 5% interest rate, the 16^th year for the 7% rate and the 19^th year for the 10% rate.

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