Fixed Rate Loan Or Variable Rate Loan – Which One Is Right For You?
Interest rate matters when looking for a good deal on your home loan. When you take out a home loan, a very important thing you would need to decide on is whether to go with a fixed interest rate, or with a variable interest rate. A home loan is a long-term debt and commitment with small differences in interest eventually adding up.
In the dilemma between a fixed and a variable interest rate on a home loan, which would you choose? We help you weigh up the pros, and cons of fixed and variable interest rates for your mortgage in this blog post.
The Certainty of a Fixed Interest Rate
A fixed interest rate is a guaranteed interest rate that stays the same for the amount of time agreed upon during the loan settlement. This means a fixed and predictable repayment amount which makes budgeting easier.
For instance, a five-year fixed interest rate at 2% per year for a property will remain at 2% for five years regardless of economic pressures wherein interest rates may go up.
Fixed-rate home loan periods are usually between one to five years. At the end of the fixed period, you have the option to apply to fix it again or rollover to a standard variable rate for the remaining number of years on your home loan.
What are the advantages of fixed-rate home loans?
1. Fixed-rate loans make budgeting easier as repayments stay the same for the entirety of the loan period, even if interest rates rise.
2. Since the repayment amount is guaranteed with a fixed-rate loan, budgeting is easier.
3. Fixed-rate loans also have fewer features. This means not having to worry about added features that come with added costs.
What are the disadvantages of fixed rate loans?
1. When interest rates do drop, the locked nature of a fixed-rate loan prohibits its borrower from receiving any reductions on repayments. This would cause you to potentially lose out on a lot of money as you continue to pay the same amount in interest on your loan.
2. Fixed-rate loans also tend to cap the number of repayments borrowers are allowed to make. This means you cannot pay off your loan quicker as one could with a variable rate loan.
3. There is no option to redraw with a fixed-rate loan. This will only become available at the end of the fixed-rate period when the rate becomes variable.
4. Break costs if you refinance or pay your home loan off early. Refinancing is when a homeowner pays off their existing home loan and replaces it for another. This could be to lower interest rates and shorten repayment terms. Under a fixed-rate loan, the option to refinance is met with break fees, additional costs and penalties.
Enjoy the freedom and flexibility of a variable interest rate.
Variable-rate loans offer interest rates that may change throughout the life of a loan, depending on external economic factors. This means the interest rate can go up or down as the lending market changes.
What are the advantages of variable rate loans?
1. Interest rate drops mean less amount on your repayments. As variable-rate loan repayments depend on interest rates in the market, when the rates do go down, you end up paying less.
2. Variable-rate loans offer a lot of freedom and flexibility to make extra repayments. This will allow you to pay your home loan off early, and without penalty or break costs, thus saving you thousands on interest.
3. Many of those choosing to refinance their mortgage have switched to a variable rate loan to secure better rates and gain access to more loan features. Variable-rate loans offer features such as a “repayment holiday” if you are well ahead on your repayments, a redraw facility, or an offset account.
What exactly is an offset account?
An offset account is a transaction account linked to your home loan wherein the money in this account is offset against the balance of your home loan, meaning you only pay the interest on the difference between the two. For instance, if you have a loan balance of $200,000, and you have $50,000 in a linked offset account, the amount you will be charged interest on in your home loan is now reduced to $150,000 ($200,000 – $50,000 = $150,000).
An offset account essentially acts as an everyday account so the $50,000 in it is still accessible should you need it, even as it works to reduce the interest payments on your home loan. While offset accounts can be linked to either fixed or variable rate home loans, they are more commonly linked to the latter with no added transaction fees.
What are the disadvantages of variable rate loans?
1. When the interest rate goes up, so do your loan repayments as they are not fixed. Variable rates are a reflection of the current economic climate. Should the economy weaken, causing a low rate of inflation, so does the cash rate used by the Reserve Bank of Australia. This would then mean that interest rates in loans would increase. For a variable rate borrower, this would essentially mean a higher interest rate payment, which could stay the same for an uncertain amount of time.
2. More features on your home loan can come with added costs. Make sure the features attached to your home loan are worth it and benefit your needs.
3. Budgeting can be more difficult when your repayments have the tendency to go up. Your circumstances could change before the end of your loan period so be sure that you can afford possible adjustments and increases to your home loan repayment.
There is a third option you could consider if going solely with a fixed or with a variable rate doesn’t appear to be the best option for you. Many Australians opt to split their loans and enjoy the best of both worlds for their mortgage.
What is a split loan and how does it work?
A split loan lets you split your borrowing amount into two loans, which are a combination of fixed and variable. This means you can allocate a portion of your home loan to be under a fixed rate, with the remainder at a standard variable rate.
A home loan of $300,000, for example, can be split into $200,000 at a fixed rate, leaving $100,000 variable. Your repayments in this case would be set for $200,000 for as long as the fixed rate applies. Then, your repayments for the $100,000 could change, but would also allow you the chance to use an offset account or a redraw facility to reduce your loan’s overall term.
Depending on your circumstances, the apparent advantages to splitting your loan could be the best of both worlds. For the portion of the loan that is fixed, you are guaranteed the exact amount of repayment even as interest rates go up. On the other hand, there is the flexibility of a variable rate and all its features, including an offset account, for that portion of the loan attached to it.
Understanding interest rates is a crucial step before you make any investment. Research your borrowing capacity to help future-proof your purchase against charges you may not have anticipated, or rates that may rise.
A qualified mortgage broker can assist you through all of these, and help you discover the best possible ways to structure your mortgage and get the most out of your real estate investment. Get expert property finance support with our team’s extensive market knowledge, plus access to the most competitive interest rates in the market.