Fixed Loans VS Variable Loans
So you’re about to take out a home loan – should you fix the interest rate or take a variable rate…. or both?
Fixed loans – pros and cons
The interest rate will stay the same throughout the fixed period of your loan, so regardless of interest rate changes in the market, your repayments will remain unchanged – this security of an stable interest rate means you know what your repayments will be, which gives peace of mind.
The fixed rate does not last for the whole period of the loan and is typically between one and five years. After the fixed period has ended, the rate will change to a ‘revert rate’ which will be variable, and which may not be the lender’s most competitive rate. At this time, Golden Eggs Home Loans can assist you to determine if your loan is still suitable or whether it is in your best interest to switch products or re-finance to an alternative loan.
A fixed rate mortgage is often less flexible and has fewer features than variable loans – for example you may not be able to make extra or early repayments, or have access to offset accounts or redraw facilities, although some products will allow these so it is important to ensure that any fixed loan you are considering has the features that you require. Even if you are able to make extra repayments, these may be limited and if you pay over and above your allowance, you may be charged a fee.
Fixed rate loans have significant penalties for early termination (and the earlier you terminate, the higher the penalty) to compensate for the lender’s lost interest, so if there is the possibility of you selling the property, wanting to re-finance or pay out the loan during the fixed period, this type of loan would not be suitable.
Note that the fixed rate on offer at the time of initial discussion or application may change (increase or decrease) during the period from the loan application to settlement of the loan. In other words, the fixed rate on the loan may be higher (or lower) by the time the loan settles. Many lenders offer a ‘rate lock’ facility, where they charge a fee to guarantee that the rate will not move from the point of application through to settlement (generally around 0.10% to 0.25% of the loan amount).
A fixed rate loan may have a higher rate than variable rate loans, and even if the fixed rate is lower, variable rates may drop and catch up with, or become more competitive than, the fixed rate.
Variable loans – pros and cons
A variable rate home loan has a fluctuating rate for the term of your home loan, so if interest rates go up, so do your monthly repayments. Conversely, if rates go down, so do your payments – this introduces risk as no one really knows what rates will do in the future. Also, lenders do not always mimic changes made by the Reserve Bank of Australia – this makes it more difficult for you to budget and does not offer the same security as the fixed rate.
Variable rate loans are often more flexible in areas such as redraw and early repayments – in which case you can pay extra when you can afford it. Making extra repayments reduces the total interest payable on the loan, also reducing the term of your mortgage and increasing the amount of equity in your home (providing your home value remains constant or increases). If a re-draw facility is available, you can withdraw some or all of those funds if they are needed down the track. You can also pay out your loan if you re-finance to a better loan, or move house.
So what should you do?
No matter what economists, media and the market say, no one knows which way rates will go – in addition to market cycles and Australian economic conditions, there is still a lot of uncertainty and the chance of more volatility ahead.
If you are considering a fixed rate, you need to:
- check that the loan has the features you want
- understand that getting out of the loan before the fixed period expires will have financial consequences, and these could be severe
- make sure the interest rate will be honoured while the lender processes your loan (and note that there is often a fee to lock in the rate)
The key with fixed rate loans is to view them as a way to achieve repayment certainty – not necessarily as a way of saving money.
When considering a variable rate loan, you need to plan and budget for increases in interest rates, and make sure that you’re able to meet your repayment obligations should rates rise by, say, an additional 2%.
Note that you can split the home loan so it is part fixed and part variable, giving you the security that at least part of your loan is locked in at a rate you can count on. Please contact us with any questions or to discuss your options.