Highlights:

• The total amount you repay on a home loan, auto loan or any other credit facility can be significantly impacted by a change in interest rates.
• Your credit score, credit report and and other financial details are factors lenders take into account when deciding on what credit terms you will be offered.
• Securing a lower interest rate means you'll pay less over the life of a loan.
   

What exactly is interest?

Interest rates are a fundamental part of our financial lives, influencing everything from car loans to credit cards. But what are they, and how do they really impact your financial health? 

Think of interest as the cost of borrowing money. When you take out a home loan or personal loan, for example, you're not just paying back the original amount you borrowed (the principal); you're also paying a percentage of that amount as a fee to the lender. This fee is the interest.

If your lender views you as a reliable borrower with a strong history of managing credit responsibly, as detailed in your credit report, they are more likely to offer you better terms such as a lower interest rate. Conversely, a higher perceived risk may lead to a higher interest rate.

The total interest you pay can fluctuate based on the loan's duration and whether the rate is fixed or variable. A fixed interest rate remains the same throughout the agreed loan term, offering predictability in your repayments. A variable interest rate can change over time, causing your repayments to increase or decrease over the term of your loan.

Based on this example, choosing a loan with an 8.5% pa rate instead of 7.5% pa would cost you an extra $1,005. At 9.5% pa, you'd be paying $2,024 more than the 7.5% pa option. This calculation doesn't even include any other fees the lender may charge.

Note: The results from this calculator should be used as indication only. There are many variables that could influence the total interest paid.
Source: https://www.loanmarket.com.au/calculators/car-loan-repayment-calculator 
Calculator assumptions: https://www.loanmarket.com.au/calculators/car-loan-repayment-calculator 

How are interest rates decided?

Lenders in Australia have their own specific lending criteria, but they generally assess several key elements to determine the interest rate they offer you. These include:

• Your credit report and score: Your history of managing your finances is a strong indicator of your reliability as a borrower. Lenders will review your credit report from a credit reporting body like Equifax to assess your repayment history, existing debts, and any past issues like defaults. They also take into account positive data such as how frequently you make repayments on time. A stronger credit score may help unlock more favourable terms, such as lower rates.
• Your financial situation: Lenders will look at your income, your employment stability, and your regular living expenses to ensure you can comfortably manage the repayments.
• The loan itself: The type of loan (e.g., secured like a car loan, or unsecured like a personal loan), the amount you want to borrow, and the length of the loan term all play a role.
• Broader economic factors: The official cash rate set by the Reserve Bank of Australia influences the rates lenders offer on their products, particularly for variable-rate home loans.

While paying interest is often an unavoidable part of borrowing, it pays to be proactive. You can help show your credit management abilities in a positive light by taking steps to improve your credit health.
 

Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstance before acting on it, and where appropriate, seek professional advice from a finance professional such as an adviser.