Fixed-rate vs variable rate home loans

When getting a new home loan, you must choose a fixed or variable interest rate. Your choice and options will depend on your circumstances.

Home Ownership
Erin Howell

When buying a home, an important consideration is your loan type, as this affects your repayments and obligations.

A fixed rate loan has the same interest rate for a set borrowing period, while variable rate loans have an interest rate that changes over time. Homeowners who prefer predictable payments may prefer the certainty of a fixed rate loan, as they know the interest rate won't change for the duration of the contract. The cost of a variable rate loan can increase or decrease over time, often in alignment with the cash rate. Borrowers who assume interest rates will decline tend to choose variable rate loans. In general, variable rate loans have lower interest rates, whereas fixed interest rates tend to be slightly higher. In Australia, it's also possible to opt for a combination of a fixed and variable interest rate for different portions of your mortgage, known as a split loan.

Home loan rates can be confusing, and your choice can significantly impact your monthly repayments, so this article will help distil some of the facts. 

Your personal and financial circumstances will help you determine which option between a home loan with a fixed rate term, variable interest rate, or a split loan is best for you.

Advantages of a fixed rate home loan

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 cannot raise your interest rate, and your loan repayment will stay steady, regardless of variable rate changes.

Fixed rate home loans offer an easy way to plan and budget, as you know the precise amount you'll pay each month for that fixed loan term. 

Typically when your fixed rate ends, you will roll onto the current variable rate with your lender, although it is best to check the specifics before you sign on. 

Fixed rate mortgages can protect 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.

Considerations for a fixed interest rate home loan

In return for offering certainty of payments, a fixed home loan tends to have additional restrictions that reduce your flexibility.

Some lenders will restrict the amount of extra repayments you can make during your fixed loan period; for example, some institutions may allow you to pay off an additional $10,000 dollars per year, but anything more than this may result in an early payout penalty.

If you opt to pay off more money than you're obligated to, you may be unable to take this out during your fixed rate period—a common feature of a variable loan.

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 won't be able to reduce your interest payments via savings.

If you expect interest rates to fall, you may not want to be locked into today's rate. 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.

Advantages of a variable rate home loan

A variable-rate home loan offers significantly more flexibility than a fixed rate, which 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, typically around 30 years. 

The interest rate on your loan is the result of many factors. These include; the size of your loan, the cost involved for your lender and, most importantly, the cash rate set by the Reserve Bank of Australia (RBA). 

The cash rate is the interest it charges banks to borrow RBA money.

If the RBA increases or decreases the cash rate, lenders will typically pass on this cost or saving to borrowers. For example, if the RBA reduces the cash rate by 1%, banks decrease interest rates by 1%. Similarly, if the cash rate increases by 1%, banks may pass on a 1% rate hike to borrowers. This means that your home loan interest rate is largely tied to the overall health of the Australian economy. 

On a variable-rate home loan, you can make unlimited repayments and pay more than your minimum repayment, and you can also typically redraw any additional repayments.

Considerations for a variable interest rate loan

While a variable-rate loan can help you pay off your home loan sooner, and it will also give you the advantage of capturing 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.

Knowing that your repayments can significantly increase when your home loan rates rise is essential. Rates have risen 2.75% between May 2022 and November 2022, driving significant price increases for borrowers.

This structure can make it harder to budget for the future as it is impossible to know with certainty the cost of your loan in future.

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 part 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 and give you some advantage if rates do drop.

Where to next?

When comparing interest rates, many first-home buyers must remember that quoted repayments often exclude the principal repayment. So when you're doing your sums, make sure you're factoring in your principal payments, too, not just the interest payments that sit on top.

Consider your long-term financial goals and short-term needs when defining which option is right for you. You can find independent financial advice online using the Government register, or speak with a mortgage broker to get a better idea of costs, fees and additional costs of your loan. 

Disclaimer: This article is intended to be general and is not personal financial product advice. It does not consider your objectives, financial situation, or needs. In particular, you should seek independent financial advice and read the relevant product disclosure statement (PDS) or other offer documents before making an investment decision in relation to a financial product (including a decision about whether to acquire or continue to hold).

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