Choosing Between Fixed and Variable Rate Home Loans
What is the difference between fixed and variable?
A fixed-rate loan stays constant at an agreed-upon rate for a predetermined period, usually, 1-5 years, after which another fixed-rate can be agreed upon or, the rate will revert to the standard variable rate. Because the rate is fixed, the loan repayments do not fluctuate, which is desirable for borrowers who like to know exactly how much they’ll be paying.
A variable-rate can vary up or down at any given time, at the lender’s discrepancy, which can be influenced by factors such as the RBA official cash rate and competitors’ rates. The floating nature of the rate means that the monthly repayments can fluctuate as the rate changes.
Flexibility Vs Certainty
The certainty of a fixed-rate makes budgeting simple as you know exactly how much you’ll be paying back for the fixed term. The stability of a fixed-rate is beneficial as you won’t be affected by a rate rise like you would if you had a variable-rate. This is an important factor for anyone needing to stick closely to a budget if money is tight. For anyone with a variable-rate who isn’t prepared for a rate rise, they could be subjected to significant stress due to the increase in repayments. The other side of a rate rise is a rate drop which hasn’t been uncommon in Australia. Having a fixed-rate means you will miss out on reaping the benefits of rates dropping.
The flexibility of a variable-rate allows for extra repayments to be made, which can see you save thousands of dollars in interest costs and pay off your mortgage much faster. With making extra repayments comes a redraw facility which works like a savings account. Any extra repayments you make reduces the loan amount and offsets the interest costs with the added flexibility of being able to redraw the money at any time you choose. Fixed-rate loans generally don’t allow extra repayments or they’ll be capped at a low amount and a redraw facility is usually not available.
A variable-rate gives you the freedom to refinance or sell your home without having to pay a break fee that would apply to a fixed-rate loan being broken within the fixed term.
To get the best of both worlds, splitting your loan into a fixed portion and a variable portion is an option. This gives you the flexibility to make extra repayments while managing some of the risks present in an interest rate rise.
There are no rules regarding how much you allocate to the fixed portion and how much is assigned to the variable portion, so you are entirely free to split the loan however you deem appropriate once your goals have been taken into consideration.
There are pros and cons plus different features and fees for both variable and fixed rate loans, so it is vitally important that you take your circumstances and needs into consideration to ensure that whatever loan you decide to choose is the best option for you.