As you begin your journey towards homeownership, one of the most important decisions you’ll have to make involves the structure of your loan. The two main options available to you are a fixed rate loan and a variable rate loan, but knowing how to best structure your impending mortgage can be a confusing proposition.
The most important thing to understand is that one of these options is not inherently “better” than the other. They each have their own pros and cons, and you should choose the loan structure that makes the most sense for your personal circumstances and preferences. Only by first considering your long-term plans for the loan, along with your overall financial goals, will you be able to make the best decision that’s right for you.
What is a variable rate home loan?
A variable rate home loan is a type of loan where the interest rates rise and fall according to the changes in the property market. These are one of the most popular types of home loans offered by lenders in Australia.
This type of mortgage comes offers a variety of useful home loan features such as 100% offset account, unlimited extra repayment and redraw facilities. Most lenders don’t even charge an application fee.
What does a variable rate loan offer?
Pros:
- Easy availability: They’re readily available with most, if not all, lenders.
- Multiple features: You can get a number of useful loan features, such as the ability to make extra repayments and an offset account. This can help you lower your interest payments and you may even be able to pay down your mortgage quicker.
- Ease to refinance: You’ll have the flexibility to refinance with another lender to secure a better deal. However, if you have a fixed rate loan then you’ll need to pay discharge fees to exit the loan early, which can be quite significant.
- Decreasing interest rates: You can take advantage of any decrease in interest rates which are normally passed on to variable rates. This is because the variable rates vary according the fluctuation in interest rate. For example, even a 0.20% reduction in rates can make a significant difference in your repayments.
Cons:
- Makes budgeting harder as your repayments could go up or down.
- More loan features could cost you more.
What is a fixed interest rate home loan?
Fixed rate home loans, on the other hand, are exactly what they sound like – a loan with an interest rate that remains the same for the entirety of a fixed rate period, normally between 1 – 5 years , regardless of what is going on in the real estate market. If you lock into an interest rate of 2.15% today and in five years rates climb to 5%, you’re still paying that same 2.15% no matter what.
Fixed rate home loans are usually ideal for people who want extra security. Homeowners looking for not only low repayments but also predictability in terms of how they’re budgeting their finances over the next few years should consider taking out a fixed rate home loan.
Keep in mind, however, that if interest rates drop below your current rate you don’t get that benefit unless you break your fixed agreement or refinance. Fixed rates themselves are very low, but they do come with a break cost if your circumstances change, and are often capped if you want to make extra repayments.
What does a fixed interest rate loan offer?
Pros:
- Makes budgeting easier as you know what your repayments will be.
- Fewer loan features could cost you less.
Cons:
- You won't get the benefit if interest rates go down.
- It may cost more to switch loans later, if you're charged a
.
What to Consider Before Choosing a Loan Structure:
If you’re having trouble choosing between fixed and variable, note that it is possible for you to split your mortgage into two separate loans- one portion that is charged at a variable rate, and the other that is charged at a fixed rate. This is an effective way to get the best of both worlds; enabling you to manage the risk of interest rate fluctuations with the fixed component, but also take advantage of depreciating rates and an offset account with the variable component.
Overall, the main factors that you should consider before choosing a loan structure are:
Your Risk Appetite: Are you willing to bet that interest rates will continue to drop and want to take advantage of that when it happens? If you are, a variable rate mortgage is the way to go. If you want to lock into an already low rate and be done with it, a fixed rate option is better.
How Much You Value Flexibility: Along the same lines, do you value the flexibility of a variable rate loan structure or do you desire more predictable rates and payments offered by a fixed rate? That’s a question only you can answer.
Whether You Want an Offset Account: If you’re planning on using an offset account at all and have the ability to make extra repayments, a variable rate home loan is the obvious choice. Some lenders allow you to offset on a fixed rate mortgage, too.
How much you can afford to repay: If you’re looking to minimise your mortgage repayments, an interest-only loan might be suitable for you, though this is to the detriment of building equity in the property.
