What is a variable rate home loan?

11 January 2017

Co-author: Sam Bloom

It can be confusing, particularly when you’re new to the home loan market, to understand just what the difference is between different types of loans. Do you need an offset account or redraw facility? Should you split your loan? Will you need a guarantor?

We have articles on all those features and more, but let’s take a step back first and answer a basic question: What is a variable rate home loan? What are some of the main reasons for choosing one? We’ve covered the benefits of a variable home loan so that you can make the best decision for your future finances.

What is a variable rate home loan?

A variable rate home loan is exactly what it sounds like: a home loan on which the interest rate can fluctuate, varying up and down at any time. Unlike a fixed-rate home loan, which locks in a certain interest rate for anywhere up to 5 years, a variable interest rate is changed regularly by your lender.

Changes up or down in a variable interest rate are based on factors such as the RBA official cash rate, changes in market interest rates, or business decisions made by your financial institution.

In terms of your home loan repayments, a variable rate loan means that the monthly loan payments will change to match any change in the interest rate applied. Here’s an example of the difference a changing interest rate can make to the monthly repayments of a $400,000 home loan over a 25 year loan term:

Loan Amount Monthly Repayment at 5% p.a. Monthly Repayment at 5.5% p.a. Monthly Repayment at 6% p.a.
$400,000 $2,338 $2,456 $2,577

As you can see, a change of just 1% up or down in your mortgage’s interest rate could see you paying several hundred dollars a month more or less.General example only. Figures should not be relied on for your personal situation.

What difference could a fluctuating interest rate make to your home loan? Play around with our mortgage repayments calculator to find out.

How is it different to a fixed rate loan?

Variable rates go up and down

A fixed rate home loan  is the opposite of the variable rate we’ve described above. It locks in a certain interest rate for a certain time period, usually between 1 and 5 years depending on which product you choose.

Once you’ve taken out the loan, your interest rate won’t change at all during this period. When the fixed period ends, however, your fixed-rate loan essentially reverts to being a variable rate loan, often at a higher than average interest rate. There are also split home loans, which combine both a fixed and a variable part.

Variable rates respond to the cash rate

Another difference is that variable rate home loans are far more responsive to changes in the official cash rate. Generally, when the official cash rate falls, you should expect the interest rate on your variable rate home loan to fall soon afterwards. And when the official cash rate increases, you should expect an increase in the interest rate on your home loan almost straight away.

Fixed rate home loans, on the other hand, are not as quickly responsive to RBA cash rate decisions. In theory, their fixed interest rates have already accounted for short-term predicted rises and falls in the official cash rate.

Variable rates can be higher

At time of writing, average fixed rate home loans on CANSTAR’s database are lower than the average standard variable rate (across most fixed terms). This indicates that our financial institutions are probably expecting a further cut in the official cash rate in the near to medium term. Click the link below to compare home loan interest rates on our database:

What are the benefits of a variable home loan?

The biggest variable rate loan benefit is flexibility. While you must meet your minimum monthly repayment, you can usually pay more money each month if you so choose. This allows you to pay off your home loan faster and thereby pay less interest overall.

The ability to make extra repayments can be especially useful if you or your partner now earn more money than when you took out your loan, or if you’ve had an unexpected windfall and you’d like to make a large payment towards your mortgage. For these situations, the flexibility of a variable mortgage provides a great benefit.

Moreover, variable home loans can often result in you paying less interest over the life of your loan. While the ‘fixed’ part of a fixed rate mortgage often has a lower interest rate, the revert rate can often be higher than that of a variable rate product. There is also typically no cost penalty with a variable loan if you decide to sell your property and move. Read about potential cost penalties for fixed rate loans here.

What are the disadvantages of a variable home loan?

The main disadvantage of a variable rate loan is that your minimum repayment amount may rise or fall at any time. This makes it difficult to plan your repayments for the year with any degree of certainty, and can be a real headache if you are on a tight budget.

Moreover, your interest rate is at the mercy of your lender’s corporate decisions, the RBA’s cash rate decisions, and the market in general. While standard variable interest rates are seeing historic lows with a minimum of 3.35% p.a. at the time of writing, future inflation or market crashes could see your interest rate (and fees) change significantly.

As always, if you’re considering a variable rate home loan, be sure to do your research and thoroughly compare fixed and variable rate loans before making a decision. At Canstar, we’ve rated over 1,100 different home loan products based on the value they offer, making it easy for you to find a home loan to suit your needs.

If you’re currently considering a home loan, the comparison table below displays some of the variable rate home loans on our database with links to lenders’ websites that are available for first home buyers. This table is sorted by Star Rating (highest to lowest), followed by comparison rate (lowest-highest). Products shown are principal and interest home loans available for a loan amount of $350K in NSW with an LVR of 80% of the property value.

Before committing to a particular home loan product, check upfront with your lender and read the applicable loan documentation to confirm whether the terms of the loan meet your needs and repayment capacity. Use Canstar’s home loan selector to view a wider range of home loan products.

*Comparison rate based on loan amount of $150,000 and a term of 25 years. Read the Comparison Rate Warning


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