How Amortisation Works for a Home Loan in Australia

When you take out a home loan, you're essentially borrowing a lump sum of money that you’ll repay over time, typically in monthly instalments. The process of repaying your loan is known as amortisation. Understanding how amortisation works is crucial for managing your mortgage and ensuring you’re on track to pay off your loan in full.

What is Amortisation?

Amortisation refers to the process of paying off a loan over a set period through regular payments. These payments typically consist of two parts:

Principal: This is the original loan amount that you borrowed.

Interest: This is the cost of borrowing the money from your lender, which is calculated as a percentage of the outstanding loan balance.

In the early stages of your loan, a larger portion of your monthly payment goes towards paying off the interest. As time goes on and the loan balance reduces, more of your payment will go towards repaying the principal.

How Does Amortisation Work on a Home Loan?

Let’s break down how amortisation works in the context of a standard Australian home loan.

Loan Term: The duration over which you agree to repay the loan. Common home loan terms in Australia are 25 or 30 years.

Interest Rate: The percentage rate at which the lender charges you for borrowing the money. This rate can be fixed or variable.

Repayment Frequency: Typically, home loans in Australia are repaid on a monthly basis, though some lenders offer fortnightly or weekly repayments.

Each repayment you make consists of a portion that goes towards the interest on the loan and a portion that goes towards reducing the principal. Early in the loan term, the interest component is larger because it is calculated on the total loan balance. As the principal decreases over time, the interest portion of your repayments reduces, and more of your payment goes towards paying down the principal.

Example of Amortisation:

Let’s walk through a simple example to illustrate how amortisation works in practice.

Home Loan Details:

Loan Amount (Principal): $500,000

Interest Rate: 4% per year (fixed)

Loan Term: 30 years (360 months)

Repayment Frequency: Monthly

Step 1: Calculate the Monthly Repayment

To calculate the monthly repayment amount, we use a standard formula that factors in the loan amount, interest rate, and loan term. For simplicity, let’s assume that the interest rate is compounded monthly.

Using a mortgage calculator, we find that the monthly repayment would be approximately $2,387.

Step 2: Breakdown of First Repayment

For the first repayment, the interest is calculated on the full loan amount of $500,000. The interest portion of your first repayment is:

Interest=Interest Rate×Loan Amount12\text{Interest} = \frac{\text{Interest Rate} \times \text{Loan Amount}}{12} Interest=4%×500,00012=1,666.67\text{Interest} = \frac{4\% \times 500,000}{12} = 1,666.67

So, $1,666.67 of your first repayment goes towards paying interest.

Now, the remaining portion of your repayment goes towards paying down the principal:

Principal Repayment=Total Repayment−Interest Payment\text{Principal Repayment} = \text{Total Repayment} - \text{Interest Payment} Principal Repayment=2,387−1,666.67=720.33\text{Principal Repayment} = 2,387 - 1,666.67 = 720.33

So, in the first month, you would pay $720.33 off your principal loan balance.

Step 3: Impact on the Loan Balance

After your first repayment, your loan balance will reduce by $720.33, so the new loan balance after the first month will be:

New Loan Balance=500,000−720.33=499,279.67\text{New Loan Balance} = 500,000 - 720.33 = 499,279.67

Step 4: Breakdown of Second Repayment

In the second month, the interest is calculated based on the new loan balance of $499,279.67. The interest portion will be:

Interest=4%×499,279.6712=1,664.26\text{Interest} = \frac{4\% \times 499,279.67}{12} = 1,664.26

The remaining portion of the repayment will go towards reducing the principal:

Principal Repayment=2,387−1,664.26=722.74\text{Principal Repayment} = 2,387 - 1,664.26 = 722.74

So, with each repayment, more money goes towards paying off the principal, and less goes towards the interest.

The Amortisation Schedule

This process continues over the full term of your loan. The interest portion of your payments decreases over time, and the principal portion increases. In the early years, you will pay more interest, and in the later years, you’ll pay down the loan principal faster as your outstanding balance decreases.

You can request an amortisation schedule from your lender or use online tools to track how much of each payment is going towards the principal versus the interest. This schedule provides a detailed breakdown of every repayment over the course of your loan term.

Why Does Amortisation Matter for Home Loan Borrowers?

Understanding how amortisation works is important because it can help you:

Plan Your Finances: Knowing how much of your monthly payment is going towards interest versus principal can help you budget effectively.

Manage Your Loan: If you make additional repayments or extra lump sums, you’ll reduce the principal faster, which will ultimately reduce the interest you pay over the life of the loan.

Refinance Decisions: Understanding amortisation can help you make more informed decisions when considering refinancing options.

In Summary:

Amortisation refers to the process of gradually paying off a loan with regular payments over time, which consist of both interest and principal.

In the early stages of your home loan, the majority of your payments go towards interest, with the principal portion increasing over time.

By making extra repayments or refinancing, you can reduce your loan balance faster and save on interest over the long term.

If you’d like to learn more about how amortisation works for your specific home loan or need help understanding your loan structure, feel free to reach out. As your trusted finance broker, we’re here to help you make the most informed decisions when it comes to your mortgage.