How Do I Reduce My Effective Mortgage Interest Rate?

Good question because let’s face it buying a house, for most people is the biggest purchase of their lives. It also commonly the first and only time they face an ongoing interest charge.

As you might expect many people are not well versed in strategies to minimise their interest rate. If you’re one of them read on!

Ok, nuts and bolts, there are more than a few strategies to pay less interest on a loan. For example you might:

Strategy 1: Link an Offset Account to your home loan

Cash sitting in the account, offsets the principal of the loan and reduces the interest payable.

Strategy 2: Salary Credit to your mortgage

Have funds deducted automatically from your salary to pay off your loan, theory is what you never see in your account you never miss!

Strategy 3: Make more frequent mortgage repayments.

Pay off your principal faster and thus reduce your effective interest.

Strategy 4: Refinance your loan with a more competitive lender

Hey there’s nothing to say you have to stay with your original loan provider for the life of the loan. These days the lending marketplace is a competitive world, think of your loan as a stand- alone commodity or product that can be bought by another lender. They offer you a better interest rate to get your business, pay your original lender out in full, and you pay them back at the new rate.

These are undoubtedly some strong strategies that can save you real dollars. But one of the most effective and popular strategies is to opt for a fixed rate on either your whole mortgage or a portion of it.

Current fixed rates can be up to 0.5% lower than the variable rates so it makes sense.

So what’s in it for the banks?

Why would the bank offer this structure that’s potentially more of a win for the customer? Well two reasons I guess. Economies and interest rates change. They’re “banking” on the possibility of variable interest rates dropping below the fixed rate they’ve offered you on a portion of your loan. They also offer it out of good old fashioned competition; they want to make themselves more attractive to you as a lender. Don’t forget it can be tough out there for the banks at times too!

Let’s take a real world example and see how it works. John and Jenny have a $400,000 total mortgage on their home. If they split it up by having:

  • $200,000 at a fixed rate of 4.79 for 2 years and
  • $200,000 at a variable rate of 5.2%

They now have effectively brought their effective interest rate down to 5%- plus they have the flexibility of a $200,000 variable rate loan which should be enough debt for most borrowers for 2 years. At the end of the 2 year fixed rate they can either refix at no charge or revert to the prevailing variable rate - again at no charge. Their options are open - depending on the interest rate environment at the time. As well, they can still link an offset account to the variable rate portion.

Let’s go a step further and increase the portion of John and Jenny’s debt at the lower fixed rate of 4.79%, as follows:

  • $300,000 fixed at 4.79% for 2 years and
  • $100,000 variable at 5.2%

By having 75% of their loan now at a fixed rate they still retain, $100,000 of flexibility but their effective interest rate has now further reduced to 4.89%. And further, by fixing all but $50,000 for 2 years the effective interest rate becomes 4.84%. For most people, like John and Jenny, $50,000 of flexibility to pay down or offset is generally enough over a 2 year period.


When you’re paying down or offsetting debt the level of flexibility you need is only in line with the surplus cash or savings you have.

These days most banks not only offer this type of split loan structure without charging additional fees, (you generally just pay an annual total package fee), but also offer a discount on their standard fixed rate when you do start a package loan. 

With a structure such as this John and Jenny get the best of both worlds, a market leading interest rate with the flexibility they need. For information and assistance with this type of loan structure, or indeed any other, just call or email one of our friendly Rate Detective team today. We’ll make sure you know all about the strategies and structures relevant to you.

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Published on July 7-th, 2014 in Home Loans
Damon Rasheed is the CEO of Rate Detective, an Australian financial service comparison sites specialising in Life Insurance, Income Protection Insurance and home loans. Damon holds a Master's Degree in Economics from the University of Melbourne and has been involved in many start-up internet businesses.
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