Whether refinancing or taking out a home loan for the first time, a competitive rate could save you thousands of dollars. So should you go fixed, variable, or even a combination of the two?
One of the main questions we get asked by clients when choosing a home loan is whether they should opt for a fixed or variable interest rate. Like many decisions relating to your mortgage the best loan for you depends on your personal wants, needs and situation. What will work for you will not for the next person.
But whether refinancing or taking out a home loan for the first time, a competitive rate could save you thousands of dollars. So should you go fixed, variable, or even a combination of the two?
All these options have their advantages and disadvantages – so how do you choose? Let’s get into some of the pros and cons of each.
Variable loans are the most popular loan in Australia. Unlike the US and many European countries who offer long term fixed mortgages of up to 30 years, over 70 per cent of home loans across the nation are variable. This is because variable home loans have more flexibility and interest-saving features than fixed home loans.
Variable home loans come with a number of features designed to save the borrower money. These can include:
- Flexibility – When on a variable home loan the borrower has a lot more flexibility with their loan. This can include free, unlimited extra repayments to pay down the principal and more opportunity and less costs involved to pay out the loan or refinance.
- Offset accounts – Offset accounts are savings accounts that ‘offset’ the loan balance remaining, saving borrowers accruing interest on the equivalent amount of the loan. Most banks will offer an offset account with a variable loan however there are only currently a few that offer any sort of offset account with a fixed rate loan.
- More facilities – Variable loans offer redraw facilities that let you dip back into extra funds you’ve put towards your home loan.
Because variable interest rates can change over time, your interest rate can drop when official interest rates decrease – i.e. when the Reserve Bank of Australia (RBA) cuts the cash rate. This can give you significant potential savings on monthly repayments.
On the flip side variable interest rates are susceptible to rate hikes as many of us have experienced over the past 24 months. If the RBA increases the cash rate, mortgage lenders pass these added costs to borrowers. Even a 0.25% rate hike can add a hundreds or thousands dollars to your monthly repayments.
While fixed interest rates don’t make up the majority in Australia, they’re still an important option to consider when comparing mortgages. So, what are their pros and cons?
- Rate certainty – Fixed interest rates don’t change during the fixed term, typically 1 to 5 years in Australia. This offers certainty for borrowers and will protect them from any rate hikes. Unfortunately, once you are locked into a fixed rate any reductions to interest rates will not be passed on to you the borrower.
- Budgeting – The main benefit of a fixed loan is greater budgeting certainty. Having a set loan amount to be paid every month provides confidence and can be especially appealing when juggling new homeownership costs.
Unfortunately, many of the other features of a variable loan are not included with fixed loans. Interest-saving features such as offset accounts and redraws are extremely rare with fixed rates, in fact only one lender in Australia currently offers a full offset account with a fixed rate.
It is also important to note that fixed rates are much more restrictive. Fixed home loans can also be significantly harder to refinance, especially if you want to leave before the fixed term expires. Breaking a fixed-term early usually comes with break costs – and these fees can be steep.
The third option which many new borrowers are not aware of is called a split rate. A split home loan uses both variable and fixed interest rates to calculate your interest payment. For example, 50% of your loan repayment could be on a fixed rate and the rest would be variable.
A split loan can be a great way to get the best of both worlds, especially with fixed rates currently being reduced by many major lenders. This can allow the borrower some confidence in their repayments for now whilst ensuring any future rate reductions are still passed on for the variable portion of the loan.
How do I choose?
As with all home loan decisions your broker is a specialist who knows the industry inside and out and is there to provide advice on the best solution for you.
Published 12 February, 2024