How a Mortgage Repayment Is Actually Calculated
A standard Australian home loan is a fully amortising debt: every scheduled payment covers the interest accrued for the period plus a slice of principal, and by the final payment the balance is zero. The arithmetic is the same one banks have used for decades:
M = P × r(1+r)^n / ((1+r)^n − 1)
Where M is the repayment per period, P is the principal (the amount you actually borrow, not the purchase price), r is the periodic interest rate (annual rate divided by the number of payments per year), and n is the total number of payments over the life of the loan.
For a monthly loan at 6.35% p.a. over 30 years, you divide 6.35% by 12 to get a monthly rate of 0.005083, and multiply 30 × 12 to get 360 payments. Plug those into the formula and you have your repayment. The same formula sits behind the ASIC Moneysmart mortgage calculator — there is no proprietary maths involved.
Principal and Interest vs Interest Only
Most owner-occupier loans in Australia are principal-and-interest (P&I). Interest-only (IO) loans flip the equation: during the IO period you pay only P × r per period, the balance does not move, and when the IO term ends the loan re-amortises over the remaining years on a higher repayment because you now have a shorter runway to pay down the same principal.
Investors historically prefer IO for the tax deductibility of interest on rental properties, but APRA tightened IO lending after 2017 and most lenders cap IO at five years for owner-occupiers and ten years for investors.
The APRA 3% Serviceability Buffer
When a bank assesses whether you can afford the loan, it does not test you at the headline rate. APRA requires authorised deposit-taking institutions to assess repayments at the contracted rate plus a 3 percentage point buffer. So a loan offered at 6.35% is stress-tested at 9.35%. This rule was lifted from 2.5% to 3.0% in October 2021 and remains in force — see APRA's prudential practice guide APG 223.
The buffer is why your repayment calculator output can look comfortable while the bank still declines you: the bank is solving the same formula at a different r.
Worked Example: $700,000 Loan, 6.35% Variable, 30 Years
- Principal: $700,000
- Annual rate: 6.35% (roughly the major-bank standard variable owner-occupier rate)
- Term: 30 years (360 monthly payments)
- Monthly rate: 0.0610 / 12 = 0.0050833
Repayment ≈ $4,242 per month. Total repaid over 30 years: $1,527,120. Total interest: $827,120 — more than the original principal.
If rates rise 1% to 7.10%, the repayment jumps to $4,704 — an extra $462/month, or $5,544 a year. At APRA's stressed rate of 9.35%, the repayment is $5,684. That gap is what serviceability buffers exist to capture.
Making one extra repayment a year on the 6.35% loan cuts roughly four years off the term and saves about $115,000 in interest, because every extra dollar of principal compounds away interest for the rest of the loan.
Common Mistakes
- Confusing the comparison rate with the actual rate. The comparison rate bundles fees into an annualised figure for a $150,000 loan over 25 years — it is a regulatory disclosure under the National Consumer Credit Protection Regulations, not the rate your repayments are calculated on.
- Ignoring the offset balance. Interest accrues daily on the net balance (loan minus offset). A $50,000 offset balance against a 6.35% loan saves around $3,050 a year in interest, tax-free.
- Assuming fortnightly halves the interest. Paying half the monthly amount every fortnight does shorten the loan, but only because you make 26 half-payments — equivalent to 13 monthly payments.
- Forgetting the buffer when refinancing. Refinancing to a lower rate still requires you to pass serviceability at rate + 3%. Borrowers stuck on legacy rates can fail the new lender's test even when the new repayment is lower.
- Treating the rate as fixed for life. Over a 30-year term, the cash rate has historically moved through full cycles. A loan that is comfortable at 6.35% needs to be survivable at 8% or higher.
