May 10, 2018
Choosing between a fixed rate and a variable rate home loan can be a tough decision to make. One option offers more stability, making it easier to budget – and sleep at night knowing your mortgage repayments aren’t going to change. The other offers better flexibility, making it easier to do things like pay down your loan faster.
Ultimately, one thing dictates how much you’ll love your fixed or variable rate loan: the market. When interest rates move, you’ll either be relieved or disappointed, depending on if they go up or down, and if changes impact your mortgage interest rate or not.
Of course, no one can predict what will happen to the economy and how mortgage rates will change in the future. Right now, there is tension in the Australian mortgage market with the Reserve Bank of Australia hitting a new record for not changing rates – the RBA has left the cash rate alone for 20 months. This has left many banks to slowly creep up rates ahead of the RBA and has pushed many homeowners to refinance now before the RBA does finally make that long-anticipated increase.
What you can do amidst the uncertainty of where rates will be three months, six months, or even three years in the future, is make sure you know what matters more to you – stable payments or more flexibility? This will dictate whether you are better off with a fixed or variable home loan.
Here is a look at the features of both fixed and variable mortgages to help you decide which type of mortgage is a better fit for your borrowing style.
A fixed mortgage rate is just what its name suggests, it is fixed. It’s not going to change. The interest rate and size of your payment are set in stone during the fixed period, which is generally from one to seven years. Once the fixed term is up, you will likely have the option to re-fix your mortgage to another fixed term, or it may automatically switch to the standard variable rate.
Taking out a fixed rate mortgage can be an excellent way to go if you like to know exactly what your payments will be in the future. It makes it easier to plan your budget. Perhaps more importantly, you’ll be able to rest easy knowing you aren’t going to have to come up with a larger repayment if rates suddenly rise. This is especially true if money is tight.
A fixed rate can also be a smart mortgage type to have when the economy is looking rather unstable and it can go either way.
There are a couple downsides to fixed interest rates. A fixed rate loan is more expensive to start with than a variable loan. It also is less likely to have features like free redraw or unlimited extra repayments. If you plan on using these features, make sure you think twice about choosing a fixed rate loan.
This type of mortgage may also have charges associated with it if you refinance to a new loan during the fixed term or if you pay it off early.
With a variable rate mortgage, when rates go up, that low variable interest rate you spent so much time comparing home loan products to find – it’s going to go up as well, and so will your mortgage repayments. On the other hand, when rates go back down, your mortgage repayments will go down as well.
The interest rate is usually recalculated yearly, but it may be adjusted more frequently. Your interest rate will change when the RBA changes the cash rate, and when your lender changes its rates.
There is no way to predict whether you are looking at an increase or decrease in the size of your payment until it happens, but you do need to be aware of the possibility of large increases. Depending on how tight your budget is, these increases could make your mortgage suddenly unaffordable.
Choice of payments
You will likely have a choice of making payments that include the principle and interest, or just interest only. You may choose to pay the interest only for a period of up to 10 years, but after that, you will need to make payments that are fully amortisable by the end of the loan term. This can be a great option if you plan on selling the property later, or if you believe that your income will be better at a later time.
If you like to have options, then a variable rate mortgage will definitely give you more of what you are looking for. For one thing, most lenders will permit you to make additional payments at any time. Doing this often can enable you to significantly reduce the interest on your home loan and pay it off early. Two more options include offset accounts and redraw. Linked accounts enable you to have money in a separate account that can be used to offset the amount of interest you are charged. Redraw lets you re-borrow money that you have already paid in advance if you should need it. You can even borrow it and then borrow it again later if you choose.
Most Australian banks will let you split your mortgage loan into more than one type of loan. You might take part of it, for instance, and turn it into a fixed loan, which will help reduce the effect of any sudden market changes and higher interest rates.
Whether you decide to go with one of the major lenders, or one of the smaller non-bank lenders, be aware that interest rates offered are usually not the same, and there are often other factors that determine the actual interest rates you receive.
Both types of loans, fixed or variable rate loans, have their own advantages. It pays to research what home loans are on offer, to determine which type of loan is right for your individual needs. If you aren’t sure what the right option for you is, you could ask for help from a mortgage specialist, such as a mortgage broker. The choice you make can have a huge impact on your finances so weigh up your options carefully.
Written by Refinancing.com.au
Refinancing.com.au is an end-to-end service that helps people refinance their home loan. We empower you to search for your home loan, and choose the process that suits you.
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