Find out which interest rate type suits you so you save the most.
Choosing between a fixed or variable rate home loan boils down to your financial situation and how likely your life or financial situation will change. If you're not sure what types of changes in your life or home are around the corner, a variable rate home loan is usually a good idea simply because they are more flexible and have lower fees.
If you need to refinance or repay your loan too while on a fixed rate loan, you are liable for an early repayment cost, which can add up to tens of thousands of dollars.
Considerations to think about
Before you make any decision regarding a fixed or variable home loan, always look closely at your current financial situation and your future goals. Be honest about your need for repayment certainty and security and work out whether you're likely to sell your home in the near future. These factors will help you make a more informed decision about which option is likely to suit your needs best.
Fixed or variable with Carla Baldock | RAMS head of products
Carla discusses some considerations when choosing between Fixed or a Variable rate loanBack to top
Fixed rate home loans
What is a fixed interest rate home loan?
A fixed rate home loan is a mortgage that has an interest that is fixed for a number of years. At the end of the fixed interest period, the loan will either revert to a variable interest rate or the borrower can choose a new fixed interest period. Fixed loan periods are from one to five years.
Click here to compare fixed home loan interest rates :
Benefits of fixed rate home loans
- Fixing: One of the biggest benefits to choosing a fixed rate home loan is the certainty that your rates cannot increase during that fixed term. If it's likely the variable rates are going to increase, this lets you avoid being stung by those rate hikes for the length of the fixed period.
- Budgeting: This makes it much easier to budget, as payments will stay the same until that fixed rate ends.
Problems with fixed rate home loans
- Inflexibility: Traditionally fixed rate home loans have been associated with being very inflexible. Many banks place limitations on the number of additional repayments you're able to make during the fixed term before penalties apply. Other restrictions may also include not having access to a redraw facility during the fixed term and not being able to link a 100% offset account to the loan to help reduce interest costs.
- Break costs: You may also find that breaking out of a fixed rate loan before the end of the fixed term may incur hefty break costs. This tends to occur if you sell your home or refinance over to another lender during the fixed rate term.
More details on fixed loans
Changes to the flexibility of fixed home loans
More recently, some fixed loans have been found offering the ability to repay above the minimum repayments to a certain limit (often around $20,000 over the fixed period) and allow redraw of those excess payments.
How long are fixed loan terms?
Most banks allow you to choose fixed rate terms that extend from one year up to five years as standard products. Some banks may even give you a custom option for 6-10 years of fixed interest.
Why shouldn't I fix my home loan?
If you see a fixed interest rate advertised for a three year fixed term, but you know you're likely to sell, renovate or refinance your home within that time, you may want to consider alternative options.
There's also the downside of being stuck paying a higher interest rate if variable rates start to fall. If your fixed term still has a couple of years to run and variable rates drop, you'll miss out on interest rate savings.
Why should I fix my home loan?
When interest rates are at historic lows, borrowers can choose to lock in the low rates. However, predicting the bottom of the interest rate cycle is a challenge that can best even the most brilliant financial minds.
Pros and cons of fixed rate home loan
- Repayments can't rise during the fixed term
- Great for security
- Helps borrowers budget into the future
- Interest rates won't drop in line with official interest rates
- Extra payments are either limited or not allowed at all
- Penalties apply for paying more than the approved extra repayment limits
- Large exit fees may apply if you break out of your loan before the end of the fixed term
- Lower flexibility with loan terms and features
Variable rate home loans
What is a variable interest rate home loan?
A variable home loan has an interest rate that can rise or fall broadly in line with official interest rates. They are the cheapest for fees and are far more flexible than their fixed counterparts.
These are the most common forms of home loans in Australia. ABS figures for February 2013 reveal that variable rate home loans make up 86.5% of all mortgages. The remaining 13.5% are fixed rate home loans.
Click here to compare variable home loan interest rates:
Benefits of variable rate home loans
- Flexibility & features. Many standard variable home loans,particularly online home loans come with a host of features these days. These features allow a greater ability to pay off a mortgage faster while slashing interest, or conversely, borrow more, redraw on extra repayments or draw down on equity.
These features allow borrowers a wider scope to use a home loan towards their specific goals.Most variable loans will allow you to make free-free additional payments at any time, with no maximum limit. You should also find that you have access to a redraw facility and more flexible repayment options.100% offset accounts, which can save tens of thousands in interest over the life of the loan and also cut years off a mortgage, are only available on variable home loans. This is a great, hands-off feature, as it saves you interest without the need to make additional repayments. It really takes care of itself as long as you keep a positive balance.
- Ease to refinance. It is cheapest to refinance from a variable rate home loan. So if you have an eye for a bargain, getting a variable rate home loan is the best way to be able to switch to lenders as cheaper interest rates become available.Remember, refinancing includes selling your home, borrowing more and renovating — not just switching to a cheaper rate. So, if you are thinking of doing any of these things in the near future, it is worth considering a variable rate home loan.
- Falling interest rates. Only variable interest home loans position borrowers to benefit from falling interest rates — which are usually passed on directly to variable rate customers.While interest rates are low, choosing a variable rate home loan isn't such a tough decision.
- Low fees. Basic variable home loans are cheaper in fees than basic fixed interest home loans. This is because there is usually a fee charged to fix an interest rate.
Problems with variable rate home loans
- interest can rise. Interest rates run in cycles. As rates start to rise again, banks pass on those increases to you. This can increase your monthly repayments and make it more difficult for some families to keep up.
Pros and cons of variable rate home loan
- Very flexible loan features
- Make any number of additional payments without penalty
- Access extra funds via the redraw facility
- Easier and cheaper to switch to another loan
- Typically lower fees
- Repayments can fluctuate as rates rise and fall
- Difficult to predict future interest rate movements
- Harder to budget when rates are in a rising trend
Split home loans
What is a split rate home loan?
A split rate home loan is a total loan amount divided into two custom portions; one locked into a fixed rate and the other variable.
If you really like the idea of fixing your interest rate, but you don't want to lose the flexible features available on your variable loan, you can choose to split your home loan.
Click here to compare split home loan interest rates:
Benefits of a split rate home loan
- Flexibility and security: Split rates let borrowers take advantage of the best aspects of both loan types. A fixed component is locked in for the next few years, so borrowers have the confidence of known repayments on that portion. A variable component gives borrowers access to many of the flexible features and additions they want — notably extra repayments and redraw.
Problems with split rate home loans
- Break costs: A part of a split rate loan is made up of a fixed rate component, so the same steep costs apply if the loan is paid out early, which make refinancing during the fixed period very costly.
- Fees: It will usually cost a couple of hundred dollars to set up the fixed rate portion of a split rate home loan — over and above what it would cost to establish a basic variable home loan.