Unlocking How Your Mortgage Actually Works
When you are buying your first home, the mortgage can feel like it just sits in the background.
But when you actually understand how your mortgage works behind the scenes, it becomes something you can work with instead of something that just happens to you. Every decision you make from how you repay to how you structure your loan can help you pay it off faster and create more flexibility over time.
In this guide, we will walk through:
🔑What a mortgage really is and how it works
🔑The key moving parts: principal, interest, repayments, and loan term
🔑How interest is calculated day to day
🔑Fixed versus variable rates
🔑How repayments change over time
🔑Why your loan term and features matter so much
This post supports Episode 21 of the First Home Unlocked Podcast: Unlocking How Your Mortgage Actually Works.
If you prefer to listen, you can tune into the full episode for examples and more detail.
What Is a Mortgage, Really?
At its core, a mortgage is simply a loan that helps you buy a property.
The bank lends you money upfront, you agree to repay it over time with interest, and the property itself is held as security for that loan. If you cannot meet your repayments, the bank has the right to take possession of the property because it is their security for the money they have lent you.
Most home loans in Australia run over a 30 year term, have an interest rate that can be fixed, variable, or a mix of both and include different features and fees, depending on the lender and loan type.
The key parts of a mortgage are:
Principal
The amount you actually borrow from the bank.
Interest
The cost you pay to borrow that money. It is what the bank charges you on top of the principal for the ability to use their funds now.
Interest Rate
The percentage the bank charges on your loan. It can be fixed for a period or variable, and it will change over time.
Repayments
The regular amounts you pay back, usually weekly, fortnightly, or monthly. These include both principal and interest.
Loan Term
The total length of time you have agreed to take to repay the loan. Commonly up to 30 years.
It might sound basic, but most people are never actually taught this in a clear way. If you are going to take on hundreds of thousands of dollars of debt, you want to know what is going on behind the scenes and which levers you can pull.
How Interest Really Works
Even though you might choose to make your repayments weekly, fortnightly, or monthly, interest is calculated daily on your outstanding loan balance.
That means:
Every day that your loan exists, you are charged interest on the amount you still owe
The higher your balance, the more interest you pay
The sooner you reduce the balance even by small amounts the less interest you will pay over the life of the loan
One thing that often shocks first home buyers is the total amount they will repay over a full 30 year term.
A Simple Example
Let us say you are buying a property for $800,000 in New South Wales using the First Home Guarantee:
Purchase price: $800,000
Five per cent deposit: $40,000
Approximate loan amount: $760,000
You would still need separate savings to cover other upfront costs like stamp duty, conveyancing, lender fees, inspections, and moving costs. If you want a deeper breakdown of those, go back to Episode 3: Unlocking the Real Costs of Buying Your First Home.
Now let us look at the loan itself, if:
Your interest rate is 5.45%
Your loan term is 30 years
You are making fortnightly repayments
And we assume for this example that the rate never changes
You would repay around $1.5 million in total over 30 years. You originally borrowed $760,000, and over the full term you would pay roughly $780,000 in interest.
So you are paying about double what you originally borrowed. That is the power of compound interest over a long period.
It can feel confronting, but understanding the full picture is what allows you to take strategic action. In future Finance 101 episodes, we walk through how tools like offset accounts, redraw, and extra repayments can dramatically reduce the total interest you pay.
Fixed vs Variable Interest Rates
Now that we have covered how interest works day to day, let us look at interest rates themselves. Your interest rate is one of the biggest drivers of:
How much your repayments are
How much interest you pay over the life of the loan
It is also the thing that tends to make headlines every time the Reserve Bank changes the cash rate. The key thing to remember is the rate you start with is not the rate you will stay with.
Variable Interest Rates
A variable rate can move up or down over time, influenced by:
The Reserve Bank cash rate
The bank’s cost of funds
Competition between lenders
Changes in lending rules and conditions
Variable rates are the most common for first home buyers because they offer more flexibility.
Advantages of a variable rate:
You can usually make extra repayments without penalty
You often get access to features like offset accounts or redraw, which help you reduce interest while keeping money available
If rates fall, more of each repayment starts going towards reducing your loan balance rather than interest
It is usually easier to refinance later without break costs
Disadvantages of a variable rate:
If rates rise, your repayments increase and that can pressure the budget
Your repayments can change over time, which makes long term planning a bit less predictable
You need to be comfortable with some movement and have buffers in place to handle higher repayments
If you like flexibility and you are willing to ride out some changes in repayments, a variable loan can work very well especially when paired with an offset account and a strong savings habit.
Fixed Interest Rates
A fixed rate stays the same for a set period, usually between one and five years. During that time:
Your interest rate does not change
Your minimum repayment stays the same
Advantages of a fixed rate:
Makes budgeting easier because repayments are predictable
Protects you from rate rises during the fixed term
Can give you a sense of stability and certainty
Disadvantages of a fixed rate:
Extra repayments are usually limited or capped each year
If you refinance, sell, or repay early, you may face break costs
Many fixed loans do not include an offset account, which reduces your flexibility
If rates fall, you may be stuck on a higher rate until the fixed term ends
Fixed rates can be useful if you value certainty or are worried about rates rising, but that stability comes at the cost of flexibility. You often lose access to the tools that help you actively reduce interest more quickly.
Rates Will Change Over Time
Most lenders assess your application using a three per cent assessment buffer. That means they test if you could still afford the loan if interest rates were three per cent higher than they are today.
It is a helpful safety net, but it does not replace your own sense of comfort.
Ask yourself:
If rates rose by two or three per cent, would I still feel comfortable?
What would that do to my monthly cash flow and lifestyle?
How much breathing room do I want to keep in my budget?
We will dig into how interest rates are set and why they move in a later episode, but for now the takeaway is simple:
Rates will always change. Understanding your budget and keeping strong buffers in place will help you stay calm, no matter what happens.
How Your Repayments Actually Work
Every repayment you make is a mix of:
Principal
Interest
At the start of your loan, most of each repayment goes toward interest, not actually reducing your loan balance. Why?
Because interest is calculated on what you still owe. At the beginning, your loan balance is at its highest, so the interest portion is larger. Even though you are paying regularly, it can feel like the balance is not moving much for the first few years. That is normal.
Example: How Your Repayment Split Changes Over Time
Using the same example:
Loan amount: $760,000
Interest rate: 5.45%
Term: 30 years
Fortnightly repayments: about $1,980
At the start of the loan:
Roughly $1,590 of each repayment goes to interest
Around $389 goes to paying down the principal
By around year 18 more of your repayment is finally going toward reducing the loan than paying interest
This is why understanding your loan structure matters. Once you know what is happening each repayment, you can make small decisions that have a big impact over time.
You can use this information strategically in the future when you refinance. For example, when you refinance in the future, keeping your remaining loan term the same instead of resetting back to a fresh 30 year term can save you a lot of interest in the long run.
Loan Term and Flexibility
Your loan term is the length of time you agree to take to fully repay your loan.
Common terms: 30 years
Other options: 15, 20, 25 years
Some lenders are now offering 35 or even 40 years
Most of our clients choose a 30 year term. That is not because they plan to take 30 years to pay it off, but because it gives them flexibility.
A longer loan term:
Keeps your minimum repayments lower
Gives you more room in your day to day cash flow
Still allows you to pay extra when your situation allows
If you are in a strong position, you can:
Make extra repayments
Use offset or redraw to reduce interest
Effectively shorten the real time it takes to pay off your loan
If life changes for example you start a family, you move to a single income or you return to study or change careers, you can pull back to the minimum repayments, knowing you have already been getting ahead.
The key trade off is the Longer term = lower required repayments and more flexibility, but more total interest over the life of the loan.
Starting with a 30 year term gives you options. You can always pay it off faster with extra repayments, but it is much harder to go the other way if you lock yourself into a very short term and then life changes.
Fees and Features: Why They Matter
Most home loans come with:
Upfront fees such as application or settlement fees
Ongoing fees such as a small monthly or annual package fee
Many loans that include an offset account charge a small annual fee, but for most people using their offset properly, the benefit far outweighs the cost.
An offset account:
Sits alongside your loan
Reduces the balance that interest is charged on
Keeps your money accessible while still helping you save interest and time
We go deeper on offset versus redraw and the power of extra repayments in the next parts of the Finance 101 series, but it is worth flagging here, the right features, used well, can save you years off your loan and tens of thousands of dollars in interest.
Final Thoughts: Don’t Just Understand the Mortgage, Use It Strategically
A mortgage isn’t just a loan. It’s a tool. Like any tool, the outcome depends on how you use it.
Understanding how your mortgage works, principal, interest, repayments, rates, and loan term gives you the clarity to make smarter decisions and the confidence to structure your loan in a way that supports your life, not restricts it.
But even with all this knowledge, there’s one thing that matters more than anything else:
The property you choose.
Government schemes, interest rate choices, loan features, they all help shape the path. But the real driver of your long-term success is buying a high-quality home in a location that matches your goals and has strong potential for growth.
That’s where we come in. We’ll help you:
Understand your numbers, your comfort level, and your buffers
Compare lenders, structures, and features that support your broader strategy
Build a mortgage plan that gives you flexibility through different seasons of life
Make sure you’re pairing your loan with the right property, one that suits your five-to-ten-year vision
For deeper context, make sure you revisit:
Those two episodes work hand-in-hand with the Finance 101 series to help you zoom out and make decisions that feel clear and intentional.
Listen to Episode 21 for the full breakdown or Book a Get to Know You Chat to map out your plan with clarity and confidence.
