When you are taking up a new home loan or refinancing, one question normally comes up is choosing between fixed or variable rate mortgage. The choice between a fixed and variable rate mortgage is a significant one for home buyers. Each type has its own set of characteristics, benefits, and drawbacks. Here’s a breakdown of the key differences and benefits:
INTEREST RATE
Fixed Rate: The interest rate remains the same for a specific period (the fixed term), typically 1 to 5 years, but can sometimes be longer. After the fixed term, it usually reverts to a variable rate or you can re-fix it at the current market rates.
Variable Rate: The interest rate fluctuates over the life of the loan, moving up or down in line with market interest rates (often influenced by the Reserve Bank of Australia’s cash rate) and the lender’s decisions.
REPAYMENTS
Fixed Rate: Your monthly repayments (of principal and interest) stay the same during the fixed term, providing predictability for budgeting.
Variable Rate: Your monthly repayments can change as the interest rate changes. This means they could increase or decrease over time.
FLEXIBILITY
Fixed Rate: Generally offers less flexibility. You may face restrictions on making extra repayments or paying off the loan early without incurring penalties (break costs). Features like offset accounts and redraw facilities are often not available during the fixed term.
Variable Rate: Typically offers more flexibility. You can usually make extra repayments without penalty, and many come with features like offset accounts (which can reduce the interest you pay) and redraw facilities (allowing you to access extra funds you’ve paid).
BENEFITS OF FIXED RATE MORTGAGE
Predictability and Stability: You know exactly what your repayments will be for the fixed term, making budgeting easier and providing peace of mind, especially if you are concerned about rising interest rates.
Protection Against Rate Rises: If interest rates go up during your fixed term, your repayments will remain the same.
Simplicity: Fixed-rate loans are generally straightforward and easy to understand.
DRAWBACKS OF FIXED RATE MORTGAGE
Missing Out on Rate Cuts: If interest rates fall during your fixed term, you will not benefit from the lower rates; you’ll be locked into the higher rate.
Potentially Higher Initial Rates: Fixed rates can sometimes be higher than variable rates at the start of the loan. It depends on the market, there are times starting rate may be lower to attract borrowers.
Less Flexibility: As mentioned earlier, they often have restrictions on extra repayments, early payouts, and may not offer features like offset accounts or redraw.
Break Costs: If you need to exit the fixed-rate period early (e.g., by refinancing or selling your home), you may incur significant break costs.
BENEFITS OF VARIABLE RATE MORTGAGE
Potential for Lower Initial Rates: Variable rates can sometimes start lower than fixed rates, leading to lower initial repayments. It depends on the market, there are times when variable rates are higher to start with.
Benefit from Rate Cuts: If interest rates fall, your repayments will also decrease, saving you money.
More Flexibility: Generally allows unlimited extra repayments without penalty and often includes features like offset accounts and redraw facilities.
Easier Refinancing: Refinancing a variable rate loan is usually easier and less costly than breaking a fixed-rate term.
DRAWBACKS OF VARIABLE RATE MORTGAGE
Repayment Uncertainty: Your repayments can increase if interest rates rise, making budgeting more challenging.
Risk of Rising Rates: You are exposed to the risk of interest rate increases, which could make your mortgage more expensive.
Requires Active Management: You need to stay aware of market trends and be prepared for potential changes in your repayments.
WHICH ONE SHOULD YOU CHOOSE?
The best choice for you depends on your individual circumstances, financial situation, risk tolerance, and expectations about future interest rate movements.
Choose Fixed If: You prefer certainty and stability in your repayments, are concerned about potential interest rate rises, and value predictable budgeting.
Choose Variable If: You are comfortable with fluctuating repayments, want the potential to benefit from falling interest rates, and value flexibility and features like offset accounts and redraw.
Many borrowers also consider split loans, where a portion of the loan is fixed and the other is variable, aiming to get a balance of both security and flexibility.
It’s crucial to discuss your options with a mortgage broker or lender to understand the specific features, fees, and potential risks and benefits of each type of mortgage based on your individual needs.
Please do not hesitate to contact me if you would like to find out more about fixed and variable rate home loans.
