What a mortgage is
A mortgage is a loan secured against real property. The lender hands you the principal amount at settlement; in return you grant them a mortgage — a legal interest in the property registered on title — that gives them the right to sell the property if you default. You repay the principal plus interest over a term, typically 25 or 30 years for an owner-occupier loan, and the mortgage is discharged once the balance hits zero.
The Australian mortgage market is dominated by the four major banks (CBA, Westpac, ANZ, NAB), with a competitive second tier of regional and online lenders plus a much smaller non-bank sector. Lenders regulated by APRA — the four majors plus most second-tier banks and credit unions — must follow APRA's prudential rules on serviceability assessment, capital weighting and loan-to-value ratio caps, which is the single biggest reason "borrowing capacity" feels harder than a back-of-envelope calculation suggests.
How repayments are calculated
Almost every Australian mortgage uses the standard amortisation formula to split each repayment between interest accrued and principal reduction. The formula for a principal-and-interest loan is:
R = P × r(1+r)n ÷ [(1+r)n − 1]
Where R is the periodic repayment, P is the loan principal at the start of the period, r is the periodic interest rate (annual rate divided by payments per year), and n is the total number of repayments. The formula produces a constant repayment that fully amortises the loan over the term. Early repayments are mostly interest; later repayments are mostly principal — your balance reduces faster in the back half of the loan.
Fortnightly repayments (26 a year) save substantial interest over a 30-year loan, because half a monthly payment paid every fortnight produces 13 monthly equivalents per year rather than 12. On a $500,000 loan at 6%, switching from monthly to true fortnightly repayments shaves about 3–4 years off the loan and saves approximately $50,000 in lifetime interest — without you paying any more per fortnight than half your existing monthly payment.
Worked example — a $600,000 loan at 6%
Take an owner-occupier loan: $600,000 principal, 6.00% variable rate, 30-year term, P&I, monthly repayments.
Monthly repayment = $600,000 × 0.005(1.005)360 ÷ [(1.005)360 − 1] = approximately $3,597.
Over the full 30 years that's $1,294,920 in total repayments — $694,920 of interest on top of the original principal. In the first repayment, $3,000 is interest charged on the opening balance and only $597 reduces principal. By year ten the split is roughly $2,554 interest / $1,043 principal. By the very last repayment, the entire $3,597 is principal with interest essentially zero.
Switch the same loan to fortnightly repayments at half the monthly amount ($1,799 per fortnight), and the loan pays off in approximately 25 years rather than 30 — saving roughly $95,000 in lifetime interest. The headline rate is unchanged; the extra payment frequency does all the work.
Principal-and-interest vs interest-only
Principal-and-Interest (P&I) loans pay down the loan balance over the term. Each repayment covers interest plus a portion of principal. By the end of the term, the loan is fully repaid. This is the default for owner-occupier loans.
Interest-Only (IO) loans pay only the interest charged each period — the balance doesn't fall. IO repayments are lower (about $3,000/month versus $3,597/month on the $600K example) and the IO period is typically 1–5 years. When the IO period ends, the loan converts to P&I on the remaining term (e.g. 25 years if you had a 30-year loan with a 5-year IO period). The new P&I repayment is higher than if you'd started on P&I from day one, because principal still has to amortise over a shorter remaining term.
IO loans are common for property investors because the interest is tax-deductible against rental income and the investor retains more cash flow for the next deposit. Owner-occupiers can usually access IO too but APRA caps how much of a bank's book can be IO, so eligibility and pricing are tighter than for investors. Always model the post-IO repayment increase before agreeing to an IO loan — many borrowers are caught out when the cliff arrives.
Fixed vs variable rates
Variable rates move with the lender's standard variable rate, which itself moves with — but is not directly set by — the RBA cash rate. Variable loans typically allow unlimited extra repayments, free redraw, and an offset account. They are the right choice if you want flexibility, expect to make extra repayments, or expect rates to fall over your hold period.
Fixed rates lock the rate for a defined fixed period (commonly 1, 2, 3 or 5 years). The repayment doesn't change during the fixed period regardless of what the RBA does. The trade-off is lower flexibility: most fixed loans cap extra repayments at $10,000–$30,000 per year, charge break costs if you exit early, and don't allow an offset account (some allow a partial offset). Fixed loans suit borrowers who want payment certainty for budgeting reasons.
Many borrowers split their loan into a fixed portion and a variable portion ("split loan") to balance certainty against flexibility. There's no extra cost to splitting — most lenders allow up to two splits within a single application.
APRA's 3% serviceability buffer
Since October 2021, APRA has required banks and credit unions ("ADIs") to assess your repayment capacity at a rate 3 percentage points above the actual loan rate. A loan offered at 6.00% is serviceability-assessed at 9.00%. The bank uses the buffer-adjusted rate to calculate the repayment that goes into the affordability test, alongside your declared (or HEM-floored) living expenses and any other commitments.
The buffer is the single largest reason borrowers feel that "the calculator says I can afford $X, but the bank says $Y" where Y is materially lower. At 6.00% headline, the buffer effectively shrinks the borrower's maximum loan size by 25–35% versus a pure-headline-rate calculation. Some non-bank lenders (not regulated by APRA) apply a smaller buffer of around 2%, which is one reason their assessed borrowing capacities can come out higher than a major bank's for the same applicant.
The buffer is intended to protect borrowers from rate shock — if rates rose 3 percentage points the borrower could, on paper, still service the loan. It's been criticised for being too tight in falling-rate environments, but APRA's official position is that the buffer is conservative enough to absorb realistic future rate moves through a credit cycle.
Offset vs extra repayments vs redraw
The interest saving from holding $50,000 in an offset account against a $600,000 mortgage at 6% is essentially the same as making a $50,000 extra repayment: both reduce the daily balance on which interest is calculated. The differences are about access and tax:
- Offset is a 100% transactional account; the balance is netted against the loan daily for interest purposes. Funds remain yours, accessible like a regular bank account. No tax issue if you draw it down.
- Extra repayments directly reduce the loan principal. The interest saving is identical to an offset of the same amount. The downside is that drawing funds back out requires using redraw — which is technically borrowing already-repaid principal back. Some lenders charge per-redraw fees; some restrict frequency.
- Redraw vs new borrowing for tax — for investors, this matters. The ATO treats redraw as a new borrowing for tax-deductibility purposes. Repaying an investment loan and redrawing the funds for a personal use can break the loan's tax-deductibility. An offset avoids this entirely because the funds are not legally repaid; they're netted.
When refinancing pays back
A rule of thumb: if you can find a rate 0.30–0.50 percentage points lower than your current variable rate, refinancing usually pays back the switching costs within 12–18 months. Switching costs typically run $500–$1,000 (discharge fee $350, registration $200–$300, new lender's establishment fee or rebate offer, possibly an LMI top-up if your LVR is above 80%).
The Australian Consumer Data Right and the federal "loan portability" rules have made refinancing easier since 2021. Most refinances complete within 4–6 weeks. Compare the new lender's revert rate (the rate after any honeymoon discount expires), not the introductory rate, when modelling the saving over a 3+ year window.
Break costs on fixed-rate loans
Breaking a fixed-rate loan before the fixed period ends (refinancing, selling, or switching to variable) triggers a break-cost calculation. The math is roughly: remaining fixed principal × (your fixed rate minus current wholesale swap rate) × remaining fixed term, with some lender-specific adjustments.
In a falling-rate environment — where wholesale rates have moved down since you fixed — break costs can run into tens of thousands of dollars on a typical mortgage. In a rising-rate environment, break costs are often close to zero. Lenders are required to provide an indicative break-cost quote on request; always ask for one in writing before deciding to break.
The AussieCalc mortgage calculator handles weekly, fortnightly or monthly P&I and interest-only scenarios on any rate and term.
Frequently asked questions
What's the difference between the headline rate and comparison rate?
The headline rate is the advertised interest rate. The comparison rate is a regulated metric that folds in establishment, ongoing service and discharge fees, standardised to a $150,000 loan over 25 years. It's a useful apples-to-apples lens for small loans but overstates the fee impact on larger loans. Always ask for a Key Facts Sheet showing fees on your actual loan size.
Will my variable rate change immediately when the RBA moves?
The lender chooses when to pass on a rate change and by how much. Most lenders update standard variable rates within two to four weeks of an RBA decision, but they're not legally obliged to pass on the full move. Fixed-rate loans are unaffected for the fixed term.
How much deposit do I really need?
Standard policy is 20% to avoid LMI. With LMI you can buy with 10%, 5% via the federal First Home Guarantee (no LMI), or 0% with a guarantor structure. Each option has trade-offs explained in the LMI guide.
Can I get a mortgage on the back of irregular income?
Yes, but lenders weight irregular income more conservatively. Most banks average 2 years of self-employed income, sometimes discounted by 20–30% if the trend is volatile. Bonus income and overtime are often only credited at 80%. Casual employment usually needs 12 months continuous service.
What is HEM and why does it matter?
HEM stands for Household Expenditure Measure — an ABS-derived benchmark of typical monthly household living costs by household type and income tier, used by every Australian lender as a floor on your declared expenses during serviceability. If you tell the bank you spend $2,000/month and HEM says $3,500 for your household, the bank uses $3,500.
Should I lock in a fixed rate?
Fix if you value payment certainty, expect rates to rise, and won't need to make large extra repayments or sell during the fixed period. Stay variable if you want flexibility or expect rates to fall. Splitting some fixed / some variable is a middle path many borrowers use.
How does an offset account work tax-wise?
For owner-occupier loans, no tax impact — offset just reduces interest paid. For investment loans, an offset is much better than extra repayments + redraw because it avoids the ATO's treatment of redraw as new borrowing for tax-deductibility purposes.
Are mortgage interest rates negotiable?
Yes, particularly for new applications and refinances. Brokers typically negotiate 10–30 basis points off the published rate, and lenders' retention teams will often match competitor offers for existing customers who threaten to leave. The published rate is rarely the best rate available.