A variable rate home loan is a type of loan where the interest rate is a floating rate where the interest rate may go up or down over the life of the loan. When this happens, your monthly repayments will also change.
The price of variable interest rate loan will change continually throughout the life of the loan as a result of external factors, including lender market position, the reserve bank’s official cash rate and the economy as a whole.
A fixed interest home loan is guaranteed not to change for the length of time you have agreed to fix it for - typically anywhere from 1 to 5 years. At the end of your fixed term, you can choose to re-fix your loan at the new offered rates or roll onto a variable rate loan.
If you want more freedom and are comfortable with the greater economy dictating your interest repayments, a variable mortgage may be the way to go. Alternatively, if you need the ability to set a budget and make mortgage repayments of a consistent amount, a fixed home loan may be the superior choice.
One of the biggest forks in the road you'll likely come across in your journey is your choice of home loan interest rate type. Choosing between fixed or variable home loans is no easy feat, but nevertheless it's important to gain a strong understanding of how each type of mortgage could affect you - particularly when you consider how much capital you're investing into the purchase.
Both loan types have their pros and cons, and what is right for one borrower may not necessarily be the best option for another. To help you make a more informed decision, we've broken down the key attributes of each type of mortgage:
The main advantage of a variable interest rate is its flexibility. The alternative type of loan, which is fixed-rate, has more restrictive and limited features. With a variable rate loan, you can make extra repayments towards your mortgage which in turn will help you pay off your loan sooner.
When comparing variable vs fixed rate, you’re choosing between flexibility and certainty. Variable home loans are more flexible but provide less certainty.
The vast majority of people in Australia choose to finance their home with variable home loans, largely due to the freedom and greater number of options they offer. More than merely providing a higher level of convenience, this flexibility can actually allow you to save substantial amounts of money over the course of your mortgage.
How? Well, one of the key benefits of taking out a variable home loan is that you're able to make extra payments on top of your scheduled installments with no penalty.
By doing so on a regular basis, you may be able to drastically cut down the length of your mortgage, reducing the overall amount of interest you'll need to pay and ultimately scoring a better return on your investment.
In addition, under a variable loan arrangement, you may be able to further strengthen your financial position if market conditions happen to swing in your favour. If interest rates go down, so will the amount of interest you are charged each month.
If the cash rate drops and your lender decides to pass the changes on to its customers, you'll have less interest to pay off. On the other hand, if the rate goes up, your repayments will increase accordingly.
As noted, variable home loans are generally more flexible than fixed alternatives, and often come with some useful features that can be used to make paying off your loan that much simpler. Some variable loan products will offer additional features like redraw facilities or loan offset sub-accounts, both of which - when used wisely can be handy financial tools.
The number one drawback of variable home loans is the level of financial uncertainty associated with them. Because variable home loans are tied to the cash rate, the amount of interest you need to pay is more or less at the mercy of wider economic conditions outside of your control.
This means that your required repayments will probably fluctuate quite significantly over the course of your mortgage, making it challenging to set - and stick to - an accurate budget.
The primary benefit of taking out a fixed-rate home loan is the greater sense of financial certainty it provides.
Under this arrangement, the interest on your mortgage is locked into the rate that you agreed to for a period of time e.g. 3 years, meaning that even if your lender increases their interest rates during that time, your repayments will be unaffected.
Essentially, the biggest benefit of a fixed home loan is having predictable payments each month. This can be helpful, particularly for first homeowners who are adjusting to making regular repayments.
Some fixed rate products will allow a limited amount of additional repayments to be made without incurring a penalty, but if you plan to make additional repayments to your fixed rate loan, it is important to understand what this limit is first.
The certainty of a fixed home loan allows you to set an accurate budget. However, the inflexible nature of a fixed home loan is both a blessing and a curse.
It provides you with a strong sense of certainty, even when the economy is going through tough times, but it also offers little in the way of choice and freedom.
The downside to your rate being locked in for a length of time occurs when interest rates are dropping around you, meaning that if you were on a variable rate you would be paying less interest than what you are on a loan that was fixed at a higher rate.
The penalties for making additional repayments beyond the allowed limit can be harsh if you unknowingly make more repayments than is allowed. Fixed-rate mortgages typically do not offer features like a redraw facility or offset sub-accounts.
In addition, if you make adjustments to your loan or sell your home within your mortgage term, you may also have to pay expensive break fees, often to the tune of thousands of dollars.
Depending on your personal circumstances, it can be difficult to choose between either option. An alternative that lenders are offering to customers is called a split loan.
This is essentially allowing you to split your total borrowing amount into two loans, one fixed and one variable. So if you had a $500,000 loan you could split that into a variable $250,000 loan and a fixed $250,000 loan.
This approach gives you the ability to make as many additional repayments as you want into the variable loan while keeping that security of a fixed repayment amount on the other loan.
When choosing between a fixed rate, variable or split rate loan, it's important to keep in mind your goals and individual financial situation.
For more information on what type of loan would suit you best, talk to one of our lending specialists or find out if you qualify today.