When it comes to purchasing a property, there are many factors to take into consideration with your home loan. Some of the most important factors are fixed interest rates and variable interest rates. It’s important to have a solid understanding of the two before making any decisions.
This article gives a quick overview to help you understand the many types of house loans and the characteristics associated with each one so that you can make the decision that is best for you and your family.
What is a Variable Interest Rate
A variable interest rate is a type of rate that fluctuates according to the changes in the market, such as the official cash rate, market conditions, and each lender’s decision. This means that your minimum repayments will fluctuate (i.e. go up or down) depending on the movement of the interest rate.
Benefits of Variable Interest Rates
Benefits of a variable rate include repayment flexibility, easier to refinance, and the potential to pay less if interest rates go down.
- Repayment flexibility: variable rates offer flexibility when it comes to making repayments, including the ability to pay off your loan faster without incurring any break costs.
- Easier to refinance it can also be easier to refinance to a different lender or loan product without attracting any break costs.
- If rates fall, you’ll benefit from lower repayments.
Disadvantages of Variable Interest Rates
On the other hand, a variable rate also has some disadvantages including:
- You may need to pay more if interest rates rise: Lenders can adjust a variable interest rate at any moment. Borrowers may expect their interest rate to change during the life of their loan. If your bank boosts interest rates, your repayments will increase as well.
- Cast flow uncertainty: Because interest rates can vary at any time, it is more difficult to forecast your mortgage repayments over time with a variable rate. As a result, a variable loan necessitates greater borrower flexibility. Using loan features such as offsets and redraw capabilities might help smooth out cash flow difficulties if unexpected occurrences occur.
When compared to fixed interest rates, variable rates can offer more flexibility and potential savings. However, they do come with the risk of higher payments if rates rise.
What is a Fixed Interest Rate
Fixed interest rates are an excellent method for maintaining the consistency of your loan repayments over the course of a specific time, which is often between one to five years. If you get a loan with a fixed rate, you won’t have to worry about your monthly payments increasing, even if the variable interest rate increases.
Benefits of Fixed Interest Rates
Benefits of fixed interest rate include:
- Ability to manage your cash flow better as you are looking into the same rates meaning your repayments will remain the same for the fixed period (typically 1 to 5 years).
- Better financial predictability and stability as your repayments will be the same for the fixed period, regardless of changes in the interest rates during that period.
Disadvantages of Fixed Interest Rates
Some disadvantages associated with fixed rates are:
- if you choose to pay off a loan with a fixed rate of interest before the end of the set period, you will almost always be required to pay high break fees.
- even if interest rates go down during the fixed period, you will still be required to pay the higher rate regardless of how the market is performing at the time.
What is a Split Loan
When it comes to borrowing money for a house loan, one possibility is to take out a split loan. When taking out a loan, you can split your loan into two distinct parts: making one section of the loan variable interest rate, while the other section fixed. For instance, if you have a house loan for $500,000 and decide to split it into two parts with a ratio of 60:40, then $300,000 of the loan would have a fixed interest rate, while the remaining $200,000 will have a variable interest rate.
Fixed rates give you more stability and have the added benefit of certainty regarding your monthly payments. On the other hand, having a variable component of your loan provides you with more freedom to pay off that portion of your loans faster with access benefits such as redraw and an offset account depending on the type of variable rate home loan you choose.
Not all lenders will offer the same type of loan. It is in your best interest to research all your possibilities before settling on the ones that suit your circumstances.