Fixed vs variable home loans – what’s the difference?
If you’re wondering whether now is the right time to fix your interest rate, you’re not alone.
The cost of living is rapidly climbing while the national wage growth struggles to keep up.
As a result, purse strings are tightening, and budgets are being readjusted to accommodate this new reality.
With rates on the rise, consumers are looking for areas to reduce their spending and locking in their interest rates can be one way to do it.
If you’re considering whether you should fix your rate or change it to a variable, keep reading for more information.
Choosing a fixed or variable rate for your home loan depends on your individual circumstances and financial position.
While you would have discussed loan rates with your lender at the time of purchase, here is a brief refresher on each rate:
Having a fixed rate on your home loan means that the interest rate on your mortgage doesn’t change for an agreed period (usually one to five years), no matter what happens with interest rates.
At the end of the fixed term period, your interest rate typically rolls over to a variable rate unless discussed prior with your broker. Breaking out of a fixed rate agreement early may expose you to costs such as break fees.
A variable home loan rate is a lot less dependable in that your mortgage repayments can change.
If interest rates fall, your mortgage repayments will decrease. However, if the Reserve Bank increases interest rates, your mortgage repayments will rise.
Variable rates can be challenging to budget for, as the repayment amount is inconsistent.
What are the benefits of fixed rates?
There are many benefits of fixing your interest rate (or even part of your interest rate). These include:
The most significant benefit to fixing your interest rate is the certainty it brings.
Having a fixed interest rate means you know how much your mortgage repayments will be, meaning you can factor them into your budget.
Set and forget
By factoring these payments into your budget, you’ll have the money debited directly from your account as you would with any other bill.
This way, you can monitor it within your outgoing monthly payments but don’t need to worry about the amount changing for your nominated period.
Rate rises won’t impact you
By locking in an interest rate, any rate rise that occurs within your selected period won’t apply to you – your repayment amount will stay the same.
This means you won’t be in doubt as to how much your repayments will be each month.
What restrictions do fixed rates have?
While fixed rates offer a variety of benefits, there are also a few limitations to be aware of before deciding to fix your rate.
Choosing to fix your loan means you’ll likely have less flexibility.
Many lenders don’t offer offset accounts or redraw facilities with fixed rates, meaning you can’t opt to pay more off your loan if you come into some extra funds or take out any additional repayments you’ve made.
You may also be limited with how many extra repayments you can make, with extra repayments generally limited to no more than $10,000 p.a. before penalties apply.
Rate cuts won’t be accessible to you
While rate rises won’t affect you, unfortunately, neither will rate cuts.
If interest rates drop while you’re on a fixed loan, you won’t benefit from them over your fixed term period.
If you make a large payment on your loan, opt to switch back to a variable rate or choose to close your account, you might need to pay a fee to the bank for exiting the fixed-rate contract.
Break fees can be significant, often more than $10,000 and, in some cases, in excess of $100,000.
These break fees are incurred because the banks need to hedge the fixed payment rate.
Break costs usually are higher when interest rates fall because banks stand to lose money on the difference that they have hedged.
Should you fix your interest rate?
With interest rates rising, you might be wondering whether you should fix your interest rate.
While there’s no one-size-fits-all answer to this question, there are some general reasons why you could opt for a fixed rate.
For those who are budget conscious, fixing your home loan rate means you know exactly what your repayments for the fixed term will be so that you can budget accordingly.
In times filled with uncertainty – from COVID-19 to inflation – this can certainly be an appealing feature of a fixed rate.
By fixing your rate when interest rates are considered ‘low’, you could potentially reduce the overall amount you end up paying on your home loan.
Over the past few years, home loan interest rates have been unprecedently low, which has greatly benefited first home buyers and homeowners alike to secure a great deal.
Over the past several months, fixed interest rates have consistently risen across all terms and lenders, meaning that it’s costing the lenders more to secure fixed-term funding for the coming years.
While the prospect of an interest rate rise may feel daunting to homeowners, try not to stress too much.
When lenders assess your ability to repay your home loan, they factor in a buffer of at least 2.5 per cent above the actual interest rate to ensure you can still afford the loan repayments if interest rates were to rise in the future.
So, while your monthly repayments will increase, it should still be a serviceable amount if your situation has remained the same from the time of your loan application.
The thought of interest rates rising might be an overwhelming one for homeowners as they navigate inflation and the rising cost of living.
Choosing whether to fix your rate is a discussion that homeowners should have with a mortgage broker, as you may not be receiving the best deal on the market.
If you need assistance with your home loan rate, talk to one of our experts today.