One of the hardest decisions an Australian home buyer has to make isn’t just which property to bid on, or which area to buy in, but the choice between a variable interest rate home loan and a fixed interest rate home loan.
The amount of interest charged on your mortgage is one of the most significant factors that determine the overall cost of the loan. If you’re considering taking out a home loan, you may be asking yourself if it’s better to lock in a rate now with a fixed rate home loan, or see how the market plays out with a variable rate home loan?
There are a range of benefits and risks to both options, and would-be borrowers will want to weigh these up carefully before applying for full approval from a home loan lender. Let’s explore the advantages and disadvantages of these two interest rate repayment options, and how home buyers can determine which one may best suit their needs.
To fix or not to fix: the benefits and risks of fixed rate home loans
A fixed interest rate is one that you lock in for a set period of time, typically 1-5 years. At the end of this fixed rate period, your interest rate will either revert to the lender’s standard variable rate (which is typically higher) or you can choose to re-fix.
Pro: Security – The main advantage of a fixed rate mortgage is that your interest rate will not change over that fixed term, regardless of how the market moves. If the Reserve Bank of Australia (RBA) hiked interest rates, for example, your home loan repayments would not change, offering a greater sense of security that your mortgage will remain affordable.
Pro: Stability – Speaking of monthly repayments changing, a fixed rate home loan also means your home loan repayments will not change throughout that fixed period. This can allow for easier budgeting for homeowners, especially as it pertains to your biggest ongoing expense. You can also easily forward plan your budgeting, as you know that the repayment amount won’t change throughout the months or years of your fixed rate period.
Con: No repayment relief – On the flip side, if interest rates were to fall again, your repayments would be locked in at a potentially higher rate than the new market average. You may see variable rate customers benefit from lower repayments, while you repay a higher interest rate until the end of your fixed period. Keep in mind that if you were to leave a fixed interest rate term early, you will typically be charged significant extra costs – also called a break fee, or break costs.
Viva la variable: the benefits and risks of variable rate home loans
A variable loan is one that is subject to market fluctuations. Meaning, if the RBA were to change the official cash rate, or if the lender adjusted its rates, your home loan rate would move too.
Pro: Enjoy interest rate falls – Your home loan interest rate and repayments are a reflection of market conditions with a variable rate home loan. By opting for a variable rate, you leave the window open for when interest rates do eventually decrease. Even if you’re applying for a home loan in a higher-rate environment, over the life of the loan, rates will fluctuate. And when you enter into a period of falling rates and cuts to the cash rate, your home loan repayments would, in theory, decrease in tandem.
Pro: Access to features – Generally speaking, home loan lenders in Australia are more inclined to reserve features, like the ability to make extra repayments, a redraw facility, or an offset account, to variable rate home loans. Reduce Home Loans breaks this mould, however, by offering helpful features with every single home loan – including fixed rate loans – for our customers.
Con: First to experience hikes – Understandably, the biggest disadvantage of a variable rate home loan is that when the Reserve Bank does hike the cash rate, and when your lender increases interest rates, your repayments rise as well. It may be worth crunching the numbers through a Mortgage Repayment Calculator, to determine if you could afford higher repayments if your variable rate home loan were to increase.
Assessing the interest rate environment
To make an informed decision around which interest rate option to choose, it’s worthwhile first taking stock of the current market. This means doing some research around how the Reserve Bank of Australia is moving, or plans to move, the cash rate, and what some experts predict about how interest rates could fluctuate.
In 2022, the RBA hiked the cash rate for the first time in over a decade, following a period of rising inflation. In fact, there were a series of cash rate hikes in 2022. This meant homeowners on variable rates experienced immediate higher repayments, and homeowners on fixed rates waited nervously to see what rates would look like when their fixed period ended. Either way you looked at it, your mortgage repayments would be increasing at one point or another.
Keep in mind that fluctuating rates are a normal part of a home loan, and rates should fluctuate over a 20-30-year mortgage. But for a generation of homeowners who had never experienced an interest rate rise, it was a reminder of the importance of choosing the best home loan rate for your needs and budget.
What to do when your fixed rate loan term ends
If you’re approaching the end of your fixed home loan term, you may be wondering what will happen with your home loan. Put simply, your lender will do one of two things:
- Offer you the chance to re-fix with them.
- Revert your interest rate to its standard variable rate – typically a much higher rate.
If rates have increased since you last fixed your home loan, or if you’ve looked at your options with your current lender and believe your new rate would be too high, it could be worth considering refinancing. Switching to a new home loan lender may allow you to take advantage of the most competitive deals in the market. And, if you signed up to a more basic no-frills home loan to begin with as a first home buyer, it could be an opportunity to add helpful features to your home loan, such as making additional repayments without penalty.
Reduce Home Loans offers some of the most competitive refinance home loans, including cash back refinancing options. It could be worth assessing these as a potential new home loan option if your fixed rate period is coming to an end.
Consider a split rate home loan
If you’re still not sure which interest rate option is the best choice for your mortgage, it may be worth considering a third option: splitting your home loan rate. A split rate home loan, as the name suggests, involves your lender dividing a portion of your home loan repayments between a fixed rate and a variable rate. It doesn’t have to be a 50/50 split down the middle either. It could be a 60/40 split, or even an 80/20 split of your loan amount, depending on your needs and assessment of the home loan market.
For example, you may do your research, determine that a cash rate hike is inevitable, but you may also want to take advantage of helpful features found with a variable rate home loan. In this instance you may choose to put the majority of your repayments on a fixed rate now to lock in a lower rate, and put the remaining part of your loan on a variable rate, to get the ‘best of both worlds’.
Whichever option you choose, it’s crucial that you remember there is more to a home loan than just the interest rate offered. You may want to compare additional factors such as fees, features and the lender itself, before you sign on the dotted line.
To discover more about which rate option may best suit your financial situation and personal circumstances or to speak to one of our helpful experts, please contact the Reduce Home Loans team today.
Any statements are general in nature and do not take into account your financial personal situation, objectives or needs. You should consider whether any statement/s is suitable for you and your personal circumstances. Before making any financial decision, consider your circumstances and the product disclosure statement.