Getting into a home and choosing a home loan can be exciting and stressful all at the same time. It can often feel overwhelming with a million different things to consider.
One of those things is choosing between a fixed or variable interest rate home loan.
‘Fixed’ and ‘variable’ interest rates are the two major types of home loans available in Australia, so it’s important to know which way is up when it comes down to deciding what’s best for you.
But what’s the difference? How do you decide?
Understanding all of this can be confusing which is why we’re breaking down the differences between the two types of interest rates and helping you decide what the best option is for your needs, your lifestyle, and your budget.
What is a Fixed interest Rate?
A fixed interest rate, as the name sounds, allows you to ‘fix’ or lock in a set interest rate for a period of time. Typically, this period is anywhere from 1-5 years with the most popular fixed terms being 1, 3, and 5 years respectively.
Once your ‘fixed term’ is up, you’ll then be reverted to your lenders’ standard variable interest rate, or consider refinancing your loan.
What are the advantages of a fixed interest rate home loan?
Locking in or ‘fixing’ your interest rate allows you to plan ahead. Noone likes being whacked with an unexpected bill and your mortgage is no different.
Being able to plan what your repayments will be with certain accuracy will allow you to better budget the money you’ll need for your repayments and help you take control of your lifestyle if you don’t plan on putting any extra cash onto your loan in the short term.
Having a fixed interest rate will also keep you protected in case your bank decides to raise its interest rates in the few months or years after you’ve taken out your loan.
There are a few limitations on a fixed loan, however, and it’s important to consider these before you lock yourself into anything.
What should I consider when deciding to go for a fixed interest rate home loan?
With the certainty of a fixed-rate home loan comes a few different things that you’ll need to consider.
- Often, during the fixed term, you won’t be able to make any additional repayments to your home loan or there will be limits placed on doing so
- If you decide to sell or refinance your home during the fixed term, some lenders will have “break costs” or other fees.
- If interest rates drop for any reason, you will be stuck paying back the loan at a higher rate.
What is a Variable Interest Rate?
A variable interest rate will fluctuate over time, usually in line with the cash rate that is set by the Reserve Bank of Australia (RBA).
This means that your repayments will also go up and down depending on what that cash rate is doing.
Variable interest rates tend to also be lower than fixed interest rates, and while on the surface that may sound good – they are subject to change at any time. This means that depending on the overall economy, you may end up paying much more interest on your loan over time.
Advantages of a fixed interest rate home loan
Along with the uncertainty of the interest rate amount, a variable interest rate actually comes with a number of benefits that may make more sense for you and your situation.
- You will be able to make extra repayments on your loan if you have the extra cash available. This means paying off your loan early and in turn, paying much less interest over the course of your entire loan.
- If you have made extra repayments, many lenders will then also allow you to redraw some of the excess from your loan in case you do ever need that money in the future.
- If interest rates go down, you’ll likely see the benefits of that and end up with lower repayments, at least while interest rates stay down.
Disadvantages of a fixed interest rate home loan
While there is a bunch of flexibility that comes with a variable interest rate, there are also a few drawbacks that are important to know about.
- If interest rates rise, you’ll be subject to higher loan repayments and there may be some surprises that come along with that if you’re on a tight budget.
- Having a variable rate means that predicting your cash flow or budgeting on a week to week/month to month basis may be more difficult.
Choosing between a fixed or variable interest rate
Between a variable and a fixed rate, there is no clear winner. It’s entirely up to you, your lifestyle, and your personal choice.
Both home loan rate types have clear benefits, and both also have their limitations.
We suggest taking a look at the bigger economical picture. If you’re worried about interest rates taking a hike in the months to come, then a fixed rate might just be exactly what the doctor ordered.
A fixed rate will keep you protected from short-term rate rises and give you the certainty of your repayments amounts to allow you to budget better.
Think interest rates might go down or want to be able to make extra repayments as you like? Then a variable interest rate might be the better option for you.
Not sure what suits you best? Try splitting your loan or consider switching when you refinance next
Depending on your bank and what loan packages they offer, you might even be able to ‘split’ your loan. Splitting means that a fixed and a variable rate are combined by nominating a certain proportion of the loan to be fixed and another proportion to be variable.
Having a split loan allows you to take advantage of both interest rate types.
What is a split loan?
Think about a split loan as having two different loans, both using a different interest rate type. You’ll get the benefits of the variable interest rate on one of your loans, while having the other loan be set at a fixed rate. This means you can hedge some of your risk against rate rises while still having the ability to make extra repayments, set up an offset account, and access redraw services.
For a simple example, you might choose to split your $500,000 home loan 50:50.
Your loan would then be split into two different loans of $250,000 each. One would be at a fixed rate and the other would be at a variable rate.
While the option to split your home loan may not be available from every lender, it can be a really good way to play on the safe side while still allowing yourself the freedom to make extra repayments if you wish.
However, with the benefits of a split loan may come extra fees, so it’s a good idea to weigh up all your options and speak to a lending expert to help you choose.
Come talk to one of our lending experts
If you’re still unsure or would like a little bit of advice on what home loan rate type is best for you – come and talk to us!