Considering the recent interest rate hikes, more than ever, it’s important to consider all options to avoid paying more on your mortgage.
Following the RBA’s 50-basis-point hike in the cash rate on 7 June 2022, it is no surprise that many banks increased their rates as well. Australia’s big four already announced that they would pass on the full value of the rate hike to customers.
What does this mean for your mortgage repayments?
The cash rate hike increases your loan rates – unless you do something and shop around to see if there’s a better rate. If consumers do nothing, you might succumb to ‘mortgage stress’ if you do not know your loan options.
In line with these events, many people are looking into fixed and variable rates to somehow ease the financial burden.
Understanding the advantages and disadvantages of fixed and variable rates will help you make well-informed decisions that may help you save more money than you think.
What’s the difference between fixed and variable rates?
A fixed-rate loan stays constant at an agreed rate for a predetermined period. Because the rate is fixed, the loan repayments do not fluctuate.
This can usually span from one to five years. After the fixed term, you can agree on another fixed rate, or the rate will revert to the standard variable rate.
On the other hand, a variable-rate loan can vary at any given time at the lender’s discretion. The rates depend on several factors, such as the RBA’s official cash rate and competitors’ rates.
Therefore, the floating nature of the rate means that the monthly repayments can fluctuate as the rate changes.
Why you should or shouldn’t consider a fixed rate
Advantages
- Makes your budgeting simpler. The certainty of a fixed rate makes budgeting simple because you know exactly how much you will pay for the fixed term. This is a key factor if you need to stick closely to your budget.
- Protects you from rate hikes. The stability of a fixed rate is beneficial since your repayments will not be affected if the official interest rates significantly increase during the fixed term.
- Provides peace of mind. Since you know how much your repayments are for the agreed term, you won’t have to constantly stress about your loans.
Disadvantages
- Misses rate drop. Unless you refinance, your repayments remain the same for the agreed term even if the official cash rate decreases. Having a fixed rate means you will miss out on reaping the benefits if the rates go down.
- Limits features. You may not be able to make extra repayments during the agreed period. Usually, a fixed rate doesn’t also allow you to access redraw or offset accounts.
- Includes more fees. If you decide to refinance during the fixed term, you will pay penalty fees, which can be quite expensive.
Why you should or shouldn’t consider a variable rate
Advantages
- Allows flexible features. A variable rate allows you to make extra repayments and access a redraw facility, which works like a savings account. Any extra repayment 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. Therefore, you may save thousands of dollars in interest costs and pay off your mortgage much faster.
- Permits refinancing. Unlike a fixed term, a variable rate gives you the freedom to refinance or sell your home without paying a break fee.
- Provides benefits from rate drops. Since a variable rate depends on the movement of the rates, your repayments will decrease if the interest rates go down. Therefore, if the market is in your favour, your interest payments will be reduced.
Disadvantages
- Yields uncertainty. You will pay more for your mortgage if the official interest rates increase. Consequently, you might be subjected to significant stress from the increase in repayments.
- Limits budgeting. Since your repayments depend on fluctuating rates, this might negatively affect how you budget your monthly household expenses.
- May confuse borrowers. A variable rate is more complicated than a fixed rate, so you might get overwhelmed by the finance jargon involved, such as margin cap, adjustment index, etc.
A mix-and-match option – Loan splitting
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 hike.
There are no rules on how much you can allocate to the fixed portion and the variable portion. In this case, you are free to split the loan however you deem appropriate once you consider your goals.
What’s your next move?
Talk to our brokers for free to help you better assess your options and find out which one works for you. This will help you make more informed decisions that best suit your needs and circumstances.
You may also qualify for a better rate and cashback offers that you are unaware of. We work with over 40 lenders and banks, so we may have better deals and options, which could save you tons of money.
Keep an eye out for our upcoming blogs on schemes and rebates! Get in touch with us at info@itssimple.com.au if you have any questions or concerns.
