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What is the difference between fixed and variable home loans?
A fixed rate home loan is one in which the interest rate remains set or ‘fixed’ for a specified period of time, whereas a variable rate loan has an interest rate that can fluctuate, going up or down depending on market forces and the decisions of your lender. It’s also possible to combine these two into a split rate home loan, potentially allowing you to take advantage of the features of both.
If interest rates are on the rise, you may be looking at your home loan and wondering whether locking in a fixed rate could help you stave off future mortgage pain. When it comes to the great rate debate, though, there’s no straightforward answer, as there are advantages and disadvantages to both fixed and variable rate loans.
How does a fixed rate home loan work?
A fixed rate home loan will have a term, generally one to five years, during which your rate will be locked. At the end of a fixed term, your lender will typically move your loan onto a standard variable rate by default – you can either stick with this, negotiate a different rate that suits you more, or refinance to another loan of your choosing. You can typically break out of a fixed rate period early if you wish, although your lender will likely charge you a break fee, and these can be substantial.
Can you switch to a fixed home loan from a variable one?
You can generally switch from a variable rate to a fixed rate one with your current lender with relative ease. If you’re interested in the fixed rate offerings of a different lender, you’d need to refinance your home loan in order to take advantage of them.
How does a variable rate home loan work?
A variable rate home loan is one in which the interest rate you pay can go up or down at any time. Generally speaking, lenders will look at the decisions of the Reserve Bank of Australia (RBA), and will adjust their rates accordingly, or leave them in place, depending on how the RBA moves the official cash rate.
Variable rate loans more often come with potentially useful features, like offset accounts and redraw facilities, that can help you to reduce the amount of interest you pay while still letting you draw on your money if you need it. They may also be more likely to come packaged with other extras such as credit cards.
What are the pros and cons of a fixed rate mortgage?
Pros
- Protection against the effects of rate rises
- Certainty in knowing exactly how much your repayment will be
Cons
- Potential to miss out on the features offered by variable rate home loans
- Limited ability to make additional repayments, with many lenders either disallowing extra repayments or limiting them to a certain amount each year during a fixed period
- Having to pay break fees if you want to exit your loan early or refinance
- Potential to miss out on savings if interest rates fall
What are the pros and cons of a variable rate mortgage?
Pros
- Greater flexibility to make additional repayments on your home loan, and reduce your interest costs using features like an offset account
- Your repayments could drop if your lender lowers its variable rates
Cons
- Potential for higher repayments if your lender puts rates up
- Uncertainty around when and if rates will rise, making your repayments harder to budget for
Are variable rates better than fixed for home loans?
There is no ‘better’ choice when it comes to a fixed or variable rate home loan. What works best for you will come down to your personal preferences and financial situation.
Should I fix my home loan interest rate?
If you’re currently on a variable rate and interest rates look likely to increase in the near future, you may be contemplating whether it’s time to lock in a fixed rate to protect against rate hikes down the line. Or maybe you're just looking for greater certainty around your repayments.
If that’s the case, it’s important to weigh up the pros and cons listed above.
If you do want to fix your rate and you choose to switch lenders in the process, it’s worth making sure the costs of refinancing won’t eat up all your potential savings.
If you’re not satisfied with your current rate, a good first step may be to contact your lender and try to negotiate a lower interest rate.
