Should I get a fixed-rate or variable-rate home loan?
When you are buying a home, one of the most important considerations for homeowners is the type of home loan you will get and how it will impact your personal finances. This is usually something home buyers don’t think about upfront, but it is important to understand how rates can impact you in the lifetime of your loan, especially when buying your first home.
An interest rate is an amount charged on top of your principal or original loan amount. This is charged by a lender for the use of their money to obtain an asset, like a home. Essentially, it is the charge you pay to the bank in order to get a loan for a home and to borrow their money for roughly 30 years.
Choosing to go with a home loan that comes with a fixed rate term or variable rate of interest will depend upon your personal and financial circumstances. It is one of the major costs to consider alongside the other upfront costs of homeownership.
Home loan rates can be confusing and can significantly impact your monthly repayments, so this article will help distil some of the facts.
Fixed rate home loans
What are the advantages of a fixed-rate home loan?
- Your repayments are always the same.
- You are not subject to interest rate rises during your fixed period.
A fixed-rate home loan is a way to ensure certainty about the interest rate available on your loan for a certain period. A fixed-rate period is typically between one to five years. During this period, your lender or bank is unable to raise your interest rate and your loan repayment will stay steady, regardless of variable rate changes. So, even if the cash rate increases, your interest rate wont.
It is an easy way to plan and budget for your new home as you will know exactly what amount will come out for that fixed loan term. Typically when your fixed rate ends, you will roll straight onto the most current variable rate with your lender, although it is best to check that with them.
This certainty protects you from interest rate rises and allows you to set financial goals for yourself and have control of your budget while you get used to your new loan.
What are the disadvantages of a fixed-interest rate home loan?
- You are limited in your ability to pay back the loan early.
- Fixed-rate loans often come with fewer features.
- Allows for less flexibility.
A fixed home loan doesn’t give you the flexibility that a variable-rate home loan can. Some lenders will have restrictions on the number of extra repayments you can pay off your loan in this period, for example, some institutions may allow you to pay off an extra $10,000 dollars per year, but anything more than this may result in an early payout penalty. If you do put extra money into the loan, you may not be able to take this out during your fixed rate period either.
Some banks will also have policies that don’t allow you to have an offset account or redraw facility on your fixed-rate loan, meaning that you can’t have any savings sitting against your borrowed amount.
If you are expecting your financial situation to change dramatically during your fixed rate period, this option may not be the best for you. It may also not be a great idea if you are expecting interest rates to fall, this is because the rate you have locked in, may be higher than the standard variable rate, meaning you won’t benefit from interest rate decreases.
Don't forget, that there are ongoing fees and payments with almost all home loans. For example, there is a risk that if you do need to refinance or break your fixed term, you may be subject to break fees if it is within your fixed period. Break costs can be considerable amounts of money so it is worth checking upfront.
Variable rate home loans
What are the advantages of a variable-rate home loan?
- More financial flexibility and additional loan features.
- Ability to repay the loan early with no additional fees.
A variable-rate home loan offers significantly more flexibility than a fixed rate. This may mean it is more suited to your lifestyle and circumstances.
With this style of loan, your interest rate can rise and fall throughout your loan period, again this is typically around 30 years. The interest rate you are given will be impacted by a range of factors. These include; the cost that is involved for your lender and more importantly the cash rate set by the Reserve Bank of Australia (RBA).
As the RBA increases the cash rate, banks and lenders will typically pass on this increase in cost to borrowers, meaning home loan interest rates, specifically variable rates are heavily impacted by the RBA. Banks aren’t able to raise rates while someone is on a fixed term.
On a variable-rate home loan, you can make unlimited repayments and pay more than your minimum repayment. You can also redraw those additional repayments.
What are the disadvantages of a variable interest rate loan?
- Your repayments may increase if rates go up
- It can be harder to budget for the future as you can’t be sure how interest rates might move
While a variable-rate loan can help you pay off your home loan sooner and it will also give you the advantage to capture a great deal when rates fall, there are also things to look out for, including the risk of rate rises in line with the RBA’s official cash rate.
It is important to know that your repayments can significantly increase when your home loan rates rise. You can get some estimates on how this can impact you by speaking to your home loan specialist or using your bank or broker interest rate calculator.
As mentioned earlier, at the end of the fixed term, your rate will change back to a variable rate loan and will be a different rate depending on whether the home is owner-occupier or an investment.
This type of structure can make it harder to budget for the future as it is harder to be certain on the set period of time that you will experience the certainty of your repayment before rates change.
What is a split fixed and variable loan?
A split-rate home loan is where you have a portion of your loan as a fixed-rate mortgage and a portion of your rate as a variable loan. This can help you get the benefits of both a fixed and variable structure and minimise risk, giving you more peace of mind for the life of the loan.
By choosing a split home loan, you can have the certainty of the fixed-rate part of your loan and the flexibility of your variable-rate loan. It can also help minimise the shock of rate increases but also give you some advantage if rates do drop.
Consider your options carefully
Overall, there is no single answer to what the best loan product is and what the right home loan option is for you. It is a very personal choice based on what best suits your goals. It is important to do independent research and find the type of home loan that feels right for your circumstance.
Mortgage brokers can be great source of information as they have a best interest duty, meaning they must give you information that benefits you alone.