When fixed rates become cheaper than variable rates | Finder

When fixed rates become cheaper than variable rates

Our experts explain why fixed rates can fall lower than variable ones, and how to decide which option is right for you.

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Fixed rate mortgage graphic

When the Reserve Bank of Australia (RBA) makes a change to the official cash rate, whether it's an increase or decrease, most home loan customers expect mortgage interest rates to change as well.

In recent years, banks and lenders have been reluctant to cut variable rate home loans in line with RBA rate changes, because their margins have been squeezed, and they were focused on boosting profits. However, they have made aggressive cuts to fixed rate home loans.

In fact, an analysis of Finder’s database shows the average standard variable rate has been consistently more expensive than fixed rate loans, from one- to five-year fixed rate periods, since the end of 2019.

So what causes fixed rates to become less expensive than variable rates? And what should you take into consideration when deciding whether to fix your home loan? The answer lies in how these different types of loans are funded.

How fixed rate home loans are funded

Fixed rates are funded by global bond markets. This means banks secure funding by selling debt in overseas markets. Fixed rate loans are generally tied to longer-term debt instruments, which usually carry higher interest rates.

The sophisticated investors who are pricing bond markets are betting about the state of the economy in the future compared to today: whether it will be better or worse.

On the other hand, variable rates are largely pegged to the RBA's official cash rate, which is the amount the Reserve Bank charges banks for overnight loans. The official cash rate currently sits at 0.10%, the lowest it has been in decades.

Fixed rates essentially reflect what the market believes will happen to the official cash rate (and by extension, the standard variable rate) in the future. If the market anticipates that the official cash rate will rise, fixed rates become more expensive, because lenders assume variable rates are likely to rise in the future. If the market believes the official cash rate (and hence variable rates) will fall in the future, fixed rates become less expensive than variable rates.

Understanding the yield curve

A yield curve is a graph that compares the yield, or interest rate, of particular securities that have the same credit quality, but that mature (or end) on different dates. In other words, a yield curve might compare the yield from a 90-day bank bill to a 10-year bond.

In normal circumstances, the 10-year bond would have a higher yield, which means a yield curve would appear like an upward slope, where the yield rises as the date of maturity lengthens.

However, in some circumstances, longer-term debt instruments become lower-yielding than short-term instruments. This happens when the market assumes that yields, or interest rates, are going to fall in the longer term. When this happens, it’s known as an inverted yield curve.

An inverted yield curve is often cited as a reason for fixed rates falling below variable rates.

It indicates that the market believes rates will be lower in the future than they are now, meaning long-term debt that backs fixed rates becomes cheaper for banks than short-term debt that backs variable rates.

The double-edged sword of an inverted yield curve

When an inverted yield curve occurs, it can represent a good opportunity to fix your loan. It means that fixed rates have become less expensive than variable rates, because banks are able to raise long-term funding for less money than it costs them for short-term funding.

The downside to this is that an inverted yield curve is often the precursor to a recession, which is exactly what happened in Australia in 2020. The inverted yield curve indicates that the bond market is betting that the economy will deteriorate, causing official cash rates to fall. Right now, the official cash rate is just 0.10%, which leaves very little room for the RBA to make any meaningful further cuts.

Australia has seen several inverted yield curves in the past decade:

  • The global financial crisis (GFC) was preceded by an inversion of the yield curve between the 90-day bank bill swap rate and 10-year bonds.
  • The yield curve inverted once more in 2013, and again in 2018, which preceded fixed rates dropping below variable ones in 2019.
  • In 2020, the yield curve inverted to the point where fixed rate loans were up to 0.80% cheaper than variable rate loans.

Should I fix my home loan?

With all of this context, should you choose to fix your home loan interest rate when fixed rates are so much lower than variable rates?

The answer to this depends on your individual circumstances, but a good place to start is working out what your goals and plans are.

When deciding whether to fix your rate or not, don't try to "beat the market", because it rarely works. Instead, consider what your goals are and whether a fixed rate might suit you.

On the plus side, in the current market, a fixed rate loan:

  • Is much cheaper than a variable loan. Switching from a variable rate to a fixed one could save you hundreds or even thousands of dollars a month, depending on your loan amount.
  • Offers a range of options. There are very cheap fixed rate loans on offer for one, two, three, four or five years.
  • Is available from a range of lenders. It's not just the Big Four banks that are offering competitive deals: A range of smaller banks and non-bank lenders have priced their fixed rate loans very cheaply, and many of these banks have more flexible lending policies that suit a wide range of borrowers.

It's important to also consider the potential risks of a fixed rate loan, and these include:

  • Less flexibility. When you lock in to a fixed period, you are committed to repaying your home loan at that rate for that period, with no exceptions. If you decide to move house or wish to sell because, for instance, you've ended a relationship, you are not allowed to end the loan without financial penalty.
  • Break fees. Speaking of financial penalty, the break fees can be hefty. In a fixed rate loan, the bank calculates how much profit they "lose" by letting you out of the loan early, and that's how much you have to pay in a break fee. It can be thousands, or even tens of thousands of dollars.
  • Overall cost. A five-year fixed rate may look very attractive now when an inverted yield curve causes it to become cheaper than the standard variable rate, but variable rates could become cheaper before the five-year fixed rate period ends.

The best reason to lock in your rate is repayment certainty. When fixed rates become less expensive than variable rates, you can lock in a rate that you know you’ll be comfortable repaying for a set period of time.

And right now, choosing to fix your loan could save you money.

Say you have a loan worth $500,000 and you're paying 2.69% on a variable rate loan. Your home loan repayment currently sits at around $2,025 per month, or $467 per week.

If you fixed your loan at 1.99% for two years, your home loan repayment drops to $1,845 per month, or just $426 per week. This is an instant saving of a couple of thousand dollars per year, and you'll have the peace of mind of knowing your repayments will remain the same, regardless of what happens to the standard variable rate or the broader economy.

Sound like a plan? Compare the latest fixed and variable rate home loans below.

Compare fixed rate versus variable rate

Data updated regularly
$
years
Name Product Interest Rate (p.a.) Comp. Rate^ (p.a.) Application Fee Ongoing Fees Max LVR Monthly Payment
HSBC Fixed Rate Home Loan Package
1.88%
2.86%
$0
$390 p.a.
80%
$546.6
$3,288 refinance cashback offer
Lock in a low fixed rate for 2 years and buy your home with a 20% deposit. Eligible refinancers borrowing $250,000 or more can get a $3,288 cashback. Terms and conditions apply.
UBank UHomeLoan Fixed
1.75%
2.22%
$0
$0 p.a.
80%
$537
This very low fixed rate is only available until 29 April 2021. Other conditions apply. A competitive fixed rate loan with no ongoing fees. Requires a 20% deposit
Westpac Fixed Option Home Loan Premier Advantage Package
1.89%
3.46%
$0
$395 p.a.
95%
$547.35
Up to $3,000 refinance cashback.
Eligible borrowers refinancing $250,000 or more can get up to $3,000 cashback. Other conditions apply.
AMP Bank Professional Package Fixed Loan
1.99%
3.1%
$0
$0 p.a.
80%
$554.81
Get a low fixed rate package with no application or settlement fee. Available with a 20% deposit. Other fees and charges apply.
Suncorp Home Package Plus Fixed
1.89%
2.85%
$0
$0 p.a.
80%
$547.35
Lock in a low fixed rate loan for two years and get the annual package fee waived in the first year. Available for borrowers with 20% deposits.
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Compare up to 4 providers

Data updated regularly
$
years
Name Product Interest Rate (p.a.) Comp. Rate^ (p.a.) Application Fee Ongoing Fees Max LVR Monthly Payment
Athena Variable Home  Loan
2.19%
2.19%
$0
$0 p.a.
60%
$569.91
Owner occupiers with 40% deposits or equity can get this competitive variable rate loan. No upfront or ongoing fees.
Macquarie Bank Basic Home Loan
2.49%
2.49%
$0
$0 p.a.
60%
$593.01
A competitive variable rate home loan for owner-occupiers. Requires a 40% deposit. Refinancers can switch with a convenient digital application.
Suncorp Back to Basics Home Loan
2.44%
2.45%
$0
$0 p.a.
80%
$589.12
A competitive variable interest rate loan with low fees. The establishment fee is waived if you borrow $150,000 or more.
Westpac Flexi First Option Home Loan
2.29%
2.72%
$0
$8 monthly ($96 p.a.)
95%
$577.55
Up to $3,000 refinance cashback.
A flexible and competitive variable rate loan. Eligible borrowers refinancing $250,000 or more can get $2,000 cashback per property plus a bonus $1,000 for their first application. Other conditions apply.
St.George Basic Home Loan
2.49%
2.51%
$0
$0 p.a.
80%
$593.01
Up to $4,000 refinance cashback
Get this low-rate variable loan with a 20% deposit and pay $0 application fee. Borrow from $150k (or $250k to be eligible for the cashback offer) (terms, conditions & exclusions apply).
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Compare up to 4 providers

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