There’s always a debate among homeowners – among themselves and the broader community – as to whether taking out a fixed-rate home loan or a variable-rate home loan is best.
With home loan interest rates rising, many homeowners may be wondering if they should fix their home loan rate instead of keeping it variable.
On the surface, it may make perfect sense to keep a rate fixed – it keeps everything consistent for an extended period and can insulate you against sudden rises in interest rates. Variable home loans also have a lot going for them too, including taking advantage of any potential rate cuts.
So, what should you choose when taking out a home loan or refinancing your home loan?
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Difference Between Fixed Rate & Variable Rate Mortgages
In Australia, there are two prominent varieties of home loans a prospective homeowner can apply for on the market. These are “Fixed Rate” and “Variable Rate” mortgages. The main point of difference is how the interest rate is determined each month, which gives you a figure you have to pay. In a fixed rate home loan, the interest rate is locked in place for a certain period – usually one to five years – and your repayments remain the same over that time.
A variable rate home loan means that your home loan interest rate is sensitive to market forces; the greatest influence being the Reserve Bank of Australia’s official cash rate. If the RBA ups the rates, your home loan interest rates and repayments go up too as they “pass on” the rate increase. The opposite happens when they decrease rates – theoretically your repayments should decrease in kind.
What are fixed vs variable home loan costs?
There are many different costs associated with any type of home loan, however the main point of difference between fixed home loans and variable home loans are how much you’ll pay in fees and charges.
Typically, variable rate home loans will have higher fees associated with the loan than its fixed rate counterpart. Variable rate home loans have many features that fixed rate home loans don’t have – which you will ultimately have to pay for. We’ll discuss these in detail in the next section.
Advantages of a fixed rate home loan
The biggest advantage to a fixed rate home loan is that your repayments will be the same from month to month until the fixed term ends. That means, for example, if you were paying $2,000 a month at the start of the fixed term home loan, it will remain that way until it expires. This makes budgeting much easier.
Owing to that, the next greatest advantage of a fixed rate mortgage is that you’re protected against interest rate rises. If rates continuously rise (as they have done throughout 2022 and 2023) you’ll still be paying the same amount regardless.
The next advantage is saving on fees and charges. Since variable rate home loans come with extra features in many cases, the fact is your bank or lender will be charging you for the privilege.
Cons of fixed rate loans
One “cost” of fixed rate loans is that they’re comparatively simple products and don’t offer the range of features that variable rate home loans do.
This may include an offset account or a redraw facility. An offset account helps reduce the balance of your home loan by “offsetting” your everyday bank balance against the loan principal. You then forgo the interest paid on your money in return. Redraw facilities allow you to take extra repayments out of the home loan to pay for major expenses such as renovations, whitegoods, or holidays, etc.
The next drawback to fixed rate loans is the most obvious one – you won’t be able to take advantage of any potential rate cuts. If the RBA cuts the official cash rate, your repayments will stay the same regardless. However, if the RBA makes deep cuts to the rate (as they did to 0.1% in late 2020, which was a record low) you could be missing out on potential savings.
Which leads to the next drawback; you will likely be barred from making extra repayments – and if you are, you’ll likely do so with some kind of fee or penalty. This really “fixes” the rate, as any potential savings you had from RBA rate cuts couldn’t be funnelled into your loan to help pay it off early.
If you pay off your fixed rate loan off early, it’s probable your bank or lender will impose a break fee. This may also extend to trying to refinance your home loan with another lender or bank.
Advantages of a variable rate home loan
The biggest advantage to a variable rate home loan is its relative flexibility in comparison to fixed rate home loans. For example, you’ll have the ability to make additional repayments on the loan so you can pay the loan off faster. You can also take advantage of offset accounts to help pay off the loan quicker. Then, you may be able to access redraw facilities to draw on money to invest, use for emergencies, or spend on activities you wouldn’t normally be able to with savings or credit cards.
The next advantage is that your repayments will go down if the RBA reduces the official cash rate. Theoretically, if you make the same repayment amount from the previous month when the cash rate goes down, you’d be making extra repayments. This could allow you to pay off the mortgage sooner.
In addition to offset accounts and redraw facilities, some variable rate home loans may also offer extras such as credit cards.
Cons of variable rate loans
The most prominent potential drawback to variable rate home loans is that it’s hard to plan or budget around variable rate repayments, as they could be low one month and be higher the next month. If the RBA cuts rates, increases rates, or if market forces influence the interest rates in any way, you may get a shock when you’re asked to make your repayment for the month. Uncertainty is the biggest risk factor in variable rate home loans.
As mentioned before, to pay for all these extra features such as offset accounts, redraw facilities, or credit cards, you will pay higher fees to support them.
If you refinance or move your home loan to another lender, you won’t be charged as high a break fee – and some lenders may waive the break fee entirely.
Which should you choose – fixed or variable rates?
There’s no real “right” choice when it comes to a fixed rate or variable rate home loan. It all comes down to which mix of pros and cons you want to deal with. If interest rates are trending upward, you may want to fix your rate for as long as possible to avoid repayment increases. Conversely, if you are finding that you’re increasing your income and want to make additional repayments without penalty, you may select a variable home loan rate as better.
If you’re unsure, you should always consult a financial adviser, so you select a home loan product that suits you and your unique circumstances.
