What is a variable rate home loan?

When you are ready to purchase your first property, it pays to know the different kinds of home loans available on the market. So what is a variable rate home loan, how often do variable rates change, and how do these loans work?

There are two main types of home loans available in Australia – variable and fixed, and there is also a third type, known as a split rate loan, that combines the two. Variable rate loans can be more flexible than their fixed rate counterparts, and can come with more features, but there are some important things to know before you commit to one.

What is a variable rate home loan?

A variable rate home loan is a loan with an interest rate that is changeable – it can go up or down at any time – depending on the decisions of your lender. This means that, in any given month, your home loan repayments could be more or less expensive with this type of home loan.

Your home loan lender can adjust a variable rate at its discretion. The lender’s decision to move rates up or down may be guided by the cash rate set by the Reserve Bank of Australia (RBA), as well as general market forces and rate movements of competing banks and lenders.

How often do variable rates change?

Variable interest rates do not change according to any particular pattern or schedule, and banks and lenders can change them whenever they wish. There are certain times, though, when banks and lenders tend to change their variable rates, and one of these is when the Reserve Bank of Australia (RBA) changes the cash rate.

The cash rate, broadly speaking, represents the cost to financial institutions of doing business with each-other. If the RBA raises the cash rate, banks and lenders may in turn raise their variable interest rates to cover the additional costs of doing business, and if the cash rate lowers, they may lower their rates in turn.

The RBA meets on the first Tuesday of each month (excluding January) to announce the movement, if any, of the cash rate. It’s typically on or soon after this day that you may well expect banks and lenders to change their variable home loan rates if the cash rate has moved.

What are the advantages of a variable rate home loan?

Some of the key advantages of a variable rate home loan are flexibility of repayments, the ability to access features such as offset accounts and redraw facilities, and the potential to pay less interest if your lender puts rates down:

• Flexibility of repayments: A variable rate home loan may allow you the ability to make additional repayments, over and above what you are required to repay each month, which can potentially mean paying down the balance of the loan faster and saving on interest in the long term. You can use Canstar’s Extra Home Loan Repayments Calculator to see what impact that might have on your loan.
• More features: It’s generally more common for variable rate home loans to come with features such as offset accounts and redraw facilities. These features can help you save money by reducing the loan balance on which interest is calculated.
• Potential for interest rate cuts: By their nature, variable interest rates can go up as well as down, so one potential advantage might be that you will be charged a lower rate from one month to the next if your bank or lender decides to reduce rates. Be aware, though, that the reverse is also true.

What are the disadvantages of a variable rate home loan?

Some potential disadvantages of a variable rate home loan include uncertainty in how your repayments will look from month to month, and the potential for higher fees.

• Uncertainty of repayments: As a variable rate can change with little notice, there’s the potential for it to be harder to stick to a set budget. You may have to adjust your budget to accommodate fluctuations in your loan repayments.
• Potential for interest rate rises: A series of steep rate hikes could see your average repayment go up by several hundred dollars per month within a relatively short period. If you feel you cannot absorb an extra cost like this, you may want to explore your options, such as fixing your home loan. If you are unable to find a solution, you may find yourself in mortgage stress.
• Potential for fees: While features such as offset accounts and redraw facilities can be convenient, they can also potentially mean paying extra fees. Depending on your circumstances, you may find that the convenience makes up for the cost in fees, but before taking out any loan product, it is important to read terms and conditions to find out exactly what fees and charges you might face.

Are variable rates cheaper than fixed rates?

Based on the current average home loan interest rates on Canstar’s database, valid at the time of writing, variable rate home loans tend to be cheaper than fixed rate ones. But this

has not always been the case and variable and fixed rates can trade places in terms of which is cheapest. It can also vary from loan to loan and not all variable loans have lower rates even if variable rates are lower on average.

But generally you may expect to pay more for a fixed rate home loan because of the certainty that comes with knowing your rate won’t go up within a certain period of time.

Within the range of fixed rate loans, at the time of writing, the average five-year fixed rate tends to be more expensive than the average one-year fixed rate. This, once again, is a trade-off for the certainty of being able to fix your rate for a longer time.

From a lender’s point of view, charging borrowers a higher rate for fixing their loan can make up for the money they might miss out on if average interest rates go up substantially during the fixed term of the loan.

What is a split rate home loan?

If you can’t decide between a variable or fixed rate home loan, a split rate home loan may be something to consider. This is a home loan in which a portion of the loan is at a fixed rate, for a set period of time, and a portion is at a variable rate, with these percentages determined by you and your lender.

An appealing aspect of a split rate loan may be that you get the convenience of a variable rate home loan, especially in terms of access to such things as offset accounts and redraw facilities, while maintaining the certainty of a fixed rate loan, with a portion of your home loan protected from rising interest rates.

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