Choosing a home loan involves more than finding a competitive rate. One of the first decisions is the type of rate: fixed, variable or a combination of the two. Each works differently, and each suits different circumstances. This guide explains the basics in plain English. It is general information only, not financial advice, and a mortgage broker or lender can explain how these options apply to your situation.
How a Variable Rate Works
A variable rate can move up or down over the life of the loan. Lenders adjust their variable rates in response to a range of factors, including changes in the cash rate set by the Reserve Bank, their own funding costs and competitive pressure. When the rate changes, your repayments generally change too.
Variable loans commonly offer more flexibility. Many allow unlimited extra repayments, and features such as an offset account or redraw facility are often available. These features can reduce the interest you pay over time.
How a Fixed Rate Works
With a fixed rate, the interest rate is locked in for an agreed period, commonly between one and five years. During that time your repayments stay the same, which can make budgeting simpler. If variable rates rise, you are protected for the fixed term. If they fall, you won’t benefit until the fixed period ends.
Fixed loans often come with restrictions. There may be limits on extra repayments, and offset accounts may not be available or may be limited. Leaving the fixed rate early, for example by selling or refinancing, can involve break costs, which can be significant. It is important to ask your lender how these would be calculated.
What Happens When a Fixed Term Ends
When a fixed period finishes, the loan usually reverts to a variable rate, unless you choose to fix again or refinance. Reversion rates are not always the most competitive, so it is worth reviewing your options a few months before your fixed term ends.
Split Loans
A split loan divides your borrowing into two parts, with one portion fixed and the other variable. This approach can offer a balance, with some certainty on part of the repayments and flexibility on the rest. The split can be any proportion, and the trade-offs of each type apply to the relevant portion.
Factors to Think About
- Budget certainty: If a rise in repayments would put pressure on your budget, certainty may be valuable.
- Flexibility: If you expect to make extra repayments, or you want an offset account, variable may suit.
- Your plans: If you might sell or refinance in the next few years, break costs on a fixed loan matter.
- Your comfort with change: Some borrowers prefer a stable repayment, others are comfortable with movement.
- Features and fees: Compare ongoing fees, offset availability, redraw and the comparison rate, not just the headline rate.
Predicting Rates Is Difficult
No one can reliably predict where interest rates will go. Decisions based purely on a guess about rate movements can backfire. A more practical approach is to consider what you can comfortably afford under different scenarios, and choose the structure that suits your circumstances and risk tolerance.
Offset Accounts and Extra Repayments
An offset account is a transaction account linked to your home loan. The balance is offset against the loan, which can reduce the interest charged. Extra repayments can also reduce your loan balance and interest. If these features matter to you, check how they work with the loan type you are considering.
Refinancing
If you already have a home loan, you can review whether your current rate and structure still suit you. Refinancing involves costs and eligibility checks, so it is worth getting advice before deciding. A mortgage broker can compare options across lenders.
Speak With the Right People
A broker or lender can explain the detail of specific products, and an accountant or financial adviser can help you consider the wider picture. Our guide to choosing between a broker and a bank is a good place to start.
Frequently Asked Questions
Is fixed or variable better? Neither is better for everyone. Fixed offers repayment certainty, and variable offers flexibility and features. The right choice depends on your finances, plans and comfort with risk.
Can I make extra repayments on a fixed loan? Often only up to a limit. Check the specific loan terms, since exceeding the cap can trigger fees.
What are break costs? These are fees that may apply if you repay or change a fixed loan before the term ends. They can be significant, so ask your lender how they are calculated.
Can I have both a fixed and a variable rate? Yes, with a split loan. You choose how much of the loan is fixed and how much is variable.
When should I review my loan? It is sensible to review your loan regularly, and especially a few months before a fixed term ends or if your circumstances change.
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This article is general information only and is not financial advice. Please speak with a licensed mortgage broker or financial adviser about your circumstances.
