Fixed vs variable home loans

Banks and lenders around Australia have begun cutting their mortgage rates ahead of an anticipated cash rate cut by the Reserve Bank of Australia next year. In particular, we’re seeing some lenders cutting their fixed rates to entice home owners, with some two and three-year fixed loans now priced noticeably lower than the average variable rate. With all this jostling to grab the attention from borrowers, we thought it was a good time to break down the pros and cons of fixed vs variable rate loans to help borrowers who may be considering their options.

What is the difference between fixed and variable home loans?

The terms ‘fixed rate home loan’ and ‘variable rate home loan’ refer to the two major types of home loan rate on the market in Australia. The difference between a fixed vs variable home loan in Australia comes down to the interest rate, and how interest is paid each month. When you take out a fixed rate home loan, the interest rate remains set in place of ‘fixed’ for a specified period of time, whereas when you take out a variable rate home loan, the interest rate can fluctuate, going up or down depending on the decisions of your lender.

If you wish, you may be able to combine a fixed and variable rate home loan together into what is known as a split rate home loan, potentially allowing you to take advantage of the features of both.

How does a fixed rate home loan work?

A fixed rate home loan is one in which the interest rate you pay is locked in place or ‘fixed’ for a set period of time. This period of time can vary, but is typically between one and five years. When you take out a fixed rate home loan, you are guaranteed that the interest rate you pay month to month will remain the same, and will not fluctuate.

At the end of a fixed term, you can choose to either move into a variable rate home loan, or refinance to either a split rate home loan or another fixed rate home loan. You can typically break out of a fixed rate home loan early if you wish, although it is likely your bank or lender will charge you a break fee to do so.

What are the pros and cons of a fixed rate mortgage?

Potential benefits of a fixed rate mortgage include:

• Protection from rate rises: In an environment of rising rates, your repayments will remain consistent, protecting you from rate rises throughout your fixed term.
• Certainty in your repayments: Knowing how much your mortgage will cost you each month can give you the ability and peace of mind to budget for other expenses.
• Potential to save on fees and charges: Variable rate home loans come with various extras, but these can be expensive, so if you’re happy without them, you can avoid some fees with a fixed rate.

Potential drawbacks of a fixed rate mortgage include:

• A lack of features: The features of a variable rate home loan can be convenient. For instance, an offset account can be used to lower the balance of your home loan while accessing funds for everyday banking. Some fixed rate loans do come with a redraw facility, but you will need to check with your lender to see if this is available.
• Potential to miss out on rate cuts: If interest rates fall, you will not get the benefit of this if you have locked your rate in for a set period of time.
• Inability to make additional repayments: Variable rate home loans generally allow you to make additional repayments to pay off the balance faster, but one of the trade-offs for the certainty of a fixed rate is that you may not be able to do this. You may be able to pay off the balance of your home loan early, although if you wish to do this – or refinance to another lender – you may be charged a break fee, which could be expensive.
• Potential to hit a ‘fixed rate cliff’: If rates go up significantly while you are on a fixed term, you may find that when your term ends, you’ll be facing much higher mortgage repayments. Whether you revert to a variable rate or refinance to a new fixed rate, you may find that either way, your options are more expensive than what you’re used to, so if you are on a fixed rate, it’s important to keep an eye on what interest rates are doing and budget accordingly.

How does a variable rate home loan work?

A variable rate home loan is one in which the interest rate you pay is not set in place, and can fluctuate, depending on the market conditions and the decisions of your lender. This means that your interest rate could go up or down, and you could end up paying more or less from one period to the next. When deciding whether to move their interest rates, lenders will typically look to the decisions of the Reserve Bank of Australia, as well as considering market forces.

Variable rate home loans typically come with more extras than their fixed rate counterparts. For example, they can come with features such as offset accounts and redraw facilities, which can allow you to repay your home loan faster, and lower your ongoing repayments. They will sometimes come packaged with other extras such as credit cards and everyday banking accounts. It is worth noting, however, that these features typically come with fees attached.

What are the pros and cons of a variable rate mortgage?

Potential benefits of a variable rate mortgage include:

• Flexibility: The ability to make additional repayments to pay off the balance of your home loan more quickly, and reduce your interest repayments using an offset account, can be appealing.
• Potential for lower repayments: If your lender puts interest rates down, you have the potential to pay less on your mortgage from one month to the next.
• Features: Variable rate home loans can help streamline your finances with features such as everyday bank accounts and offset and redraw facilities, and packaged extras like credit cards.

Potential drawbacks of a variable rate mortgage include:

• Potential for higher repayments: If your lender puts interest rates up, you have the potential to pay more on your mortgage month to month, and rate rises could make your mortgage even more expensive over time.
• Uncertainty: Rate rises can be a source of uncertainty, making it challenging to set a budget in advance if you don’t know how high your repayments could rise, depending on interest rates.
• Higher fees: Features such as offset and redraw facilities and packaged extras can be attractive, but it is worth keeping in mind that these have the potential to drive up the fees you pay.

Is variable better than fixed for home loans?

There is no ‘better’ choice between fixed and variable rate home loans, as both have pros and cons, so what is preferable will come down to your personal choice. At the present time, economists at Australia’s major banks are predicting that we may see rate cuts in the first half of 2025, following a year where rates have held at their current level. With this in mind, if you are considering a fixed rate, you may decide to opt for a shorter fixed-term mortgage while you wait to see what interest rates do from here, especially in light of the fact that many lenders have opted to cut their two and three-year fixed rates in recent times. Alternately, you might feel that a variable rate is appealing, in hopes that rates will fall throughout 2025.

You may even find that a split rate home loan, combining both fixed and variable elements, is a suitable choice for you. A split rate home loan is essentially two separate home loans, one on a fixed rate, the other variable. Some lenders may let borrowers decide what percentage of the loan to keep fixed, and for how long, and what percentage to make variable. With a split loan, you might have the convenience of features like offset accounts and redraw facilities, allowing you to pay your mortgage off more quickly, while you might also have the certainty of knowing that part of your home loan is fixed, and won’t be vulnerable to rate rises.

In any case, the best option for you will come down to your individual needs and circumstances, so it will likely be worth your while to consider the pros and cons of fixed vs variable home loans and the current interest rate climate to inform your decision.

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