What is a fixed rate home loan?

When you take out a home loan, you’ll need to pay back the amount you borrow (the principal) as well as interest. A fixed rate home loan may be an option to consider if you want the certainty of knowing your interest repayments will remain the same for a period of time.

What is a fixed rate home loan?

A fixed rate home loan is a home loan where the interest rate is locked in for a certain period of time, known as the fixed term of the loan. This means that, over this initial period, the interest rate you pay will remain the same. It also means repayments will generally remain the same until the end of the fixed term.

A fixed rate home loan is an alternative to a variable rate home loan. A variable rate is different, in that it can change over time, with lenders typically moving their rates up or down in line with the cash rate set by the Reserve Bank of Australia (RBA) and other market conditions. This means that the repayment amount is also likely to go up or down, as the interest rate changes.

It is also possible to combine a fixed and variable rate loan into what’s called a split home loan, which has features of both. This type of loan allows a borrower to have some of the loan as a fixed loan and the rest as a variable rate loan.

How do lenders calculate fixed rates?

When you take out a fixed rate home loan, your lender is guaranteeing that your interest rate will be locked in place for a set amount of time, irrespective of how market conditions change, and whether interest rates go up or down.

If lenders expect that the cash rate will rise in the future, making it more expensive for them to do business, then they might set their fixed rates higher in anticipation of this. Conversely, if they expect that the cash rate will fall, they may price their fixed rate loans more cheaply.

Of course, the cost of doing business in the future is not the only thing that determines the cost of a fixed rate loan. Generally speaking, the longer a fixed rate loan term, the more expensive it might be, as you are paying – via a higher interest rate – for the security of being protected from rate rises over a longer period of time. The higher interest rate also helps to cover the bank’s risk if rates were to rise above the interest rate of your loan.

Banks and lenders also set their rates based on what they believe will attract customers, so you might also expect them to set their fixed rates based on what they believe will be competitive in the marketplace, and what will encourage customers to borrow from their institution. This is often why banks will have conditions on their advertised rates that say they are only for new customers (although if you are an existing customer, you might be able to access the deal if you ask).

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How long is a fixed rate loan term?

The term of a fixed rate home loan will vary, depending on your needs and what your lender is willing to offer, but typically, the fixed term will last for between one and five years. After this, the interest rate will switch to a variable one, or in some cases you may be able to negotiate another fixed term with your lender.

It is worth being aware that, the longer you wish to fix your home loan term for, the higher the rate of interest you’re likely to be charged. A summary of current home loan interest rates on Canstar’s database shows that the average one-year fixed home loan rate is more than a full percentage point cheaper than the average five-year rate.  It could be worth calculating the outcome of various options, or seeking suitably qualified professional advice, before deciding on a particular loan or lender. Canstar’s Home Loan Comparison Calculator may help.

Are fixed rates cheaper than variable rates?

Based on a summary of current home loan interest rates on Canstar’s database, the average variable rate home loan is still cheaper than the average fixed rate loan. Given the changeable nature of variable rates, though, it is unclear whether this will continue in the long term.

Australia has recently been through a long period of low interest rates, thanks largely to the RBA’s decision to set the cash rate at a low point, to guide the country through the economic challenges of the pandemic. In May of 2022, the RBA began hiking the cash rate, and in turn, home loan lenders began hiking their variable rates.

Generally speaking, when the RBA hikes the cash rate, banks and lenders raise their home loan rates, too. This means that variable rate home loan borrowers have already seen some significant rises in 2022, and will likely see more in months to come.

If you’re curious about how high rates will go, recent comments from RBA governor Philip Lowe suggest that he expects the cash rate to peak at 2.5%, which, at the time of writing, could mean that the average variable home loan rate might hit 5.27%.

This, however, is still lower than the current average rate for five-year fixed home loans, which, at the time of writing, sits at 6.14%.

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What are the advantages and drawbacks of a fixed rate home loan?

While fixed rate home loans can offer you certainty in terms of your budget, they often do not have as many features that variable loans have, and you will not save money if interest rates go down. However, if interest rates go up, you will be protected from an increase in your loan cost for the period of the fixed term.

Advantages

• If you want the certainty of knowing exactly how much your monthly repayments will be for at least the first few years of your loan, a fixed rate loan can offer this, as you will know the precise amount you’ll owe each month, meaning budgeting may be easier.
• Locking in a fixed rate for your home loan could also potentially save you money in an environment of rising rates. You may find that, depending on the loan you choose, you could pay less on a fixed rate than if you had opted for a variable one, if rates were to rise significantly.
• If your lender chooses to put its rates up, increasing the interest payable on variable rate loans, your repayments on a fixed rate home loan will not be affected, and will remain the same.
• While fixed rate loans generally come without the bells and whistles of variable rate loans, such as offset accounts and redraw facilities, some offer these features for a fee. This could potentially allow you to have both the security of locking in a home loan rate and the convenience of an offset account (although it may make your loan more expensive in the long run).

Drawbacks

• The fact that your repayments remain the same month to month means that you will not save on interest if the lender decides to put its rates down, as you potentially could with a variable rate home loan.
• Fixed rate loans can lack flexibility, and in many cases you will not be able to make additional monthly repayments without being charged a fee. Similarly, they generally lack features such as offset accounts. However, even if you choose a fixed rate loan it can be worthwhile checking with the lender for its policy on repayments and whether it offers any features such as a redraw facility.
• If you choose to refinance or switch loans from a fixed rate loan, or end your contract (perhaps due to selling your house), then you will typically be charged a break fee by your lender. It’s a good idea to make sure you explore the loan’s comparison rate and read any important documentation, such as the Target Market Determination (TMD) and Key Facts Sheet (KFS), which outline the terms and conditions of the loan such as any fees and penalties.

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