There are many home loan options available. These may include the repayment type (eg. ‘principal and interest’ vs ‘interest only’ repayments) and the type of interest rate. In this article, we focus on the types of interest rate and how they can affect a home loan.
Generally, when you take out a home loan, you have two choices: a fixed interest rate or a variable interest rate.
A fixed interest rate home loan is one where your interest rate is locked in (i.e. fixed) for a certain period, typically between one and ten years. During the time your interest rate is fixed, both your interest rate and your required repayments won’t change.
A variable interest rate home loan, on the other hand, can change at any time. Lenders may increase or decrease the interest rate attached to the loan. The interest rate may change in response to decisions made by the Reserve Bank of Australia, as well as other factors. Your required minimum repayment amount will increase if interest rates go up, and decrease if interest rates fall.
Which one is better for you? It really depends on what you’re looking for in a home loan. Here are some of the pros and cons of each.
Fixed rate home loans
A fixed rate home loan can give you peace of mind that the required repayment amount will be the same during the period of the fixed term, which can be very handy when you are trying to stick to a budget.
You can generally choose the time period you would like to fix your interest rate for. Depending on the lender, this could be for up to 10 years. Generally, at the end of the fixed term your loan will roll over to a variable rate, unless you choose to repeat the process.
While a fixed interest rate can be useful to help protect you against potential interest rate rises, it can mean that you’re stuck with the fixed rate if variable interest rates decrease during the fixed period.
Fixed rate home loans generally have fewer features than variable rate home loans. For example, with a fixed rate loan you may not be able to access redraw during the period the loan is fixed.
It's also important to note that if you decide to pay off or refinance your home loan before the end of the fixed term, you may have to pay break costs. These may be significant sums of money.
Locking in the fixed rate
You might find a great fixed rate deal when you’re applying for a home loan. But that doesn’t guarantee that you’ll get that fixed interest rate when you settle on the property.
The fixed interest rate that will apply to your loan is the fixed rate offered by the lender on the day of settlement, not at the time of loan application.
You may be able to secure the fixed interest rate before settlement by paying a Lock Rate Fee.
Please discuss with your lender whether locking in the fixed rate on application is best for you.
Once your fixed rate term starts, the rate will not vary until the term expires.
Variable rate home loans
A variable rate home loan typically offers more flexibility than a fixed rate home loan. It generally comes with a range of features which may help you react to changes in your life or financial circumstances.
For example, many variable rate home loans let you make additional repayments to pay off your loan faster, and then let you redraw these additional funds if you need them in the future. Many variable rate home loans also have an offset account feature, which could help to reduce the amount of interest you pay.
A potential drawback of a variable rate home loan is that interest rates can change at any time. This means they can go up and down. It's a good idea to consider whether you can afford higher loan repayments if interest rates were to go up.
Can’t decide? Perhaps consider splitting the loan
If you can’t decide whether to go with a fixed or variable home loan, then you could consider splitting your loan between the two options.
If you split your home loan, it means that you assign a certain portion to a variable home loan, and the rest to a fixed home loan. You may choose to go 50:50, 60:40 or some other ratio. It’s up to you.
Ask your lender about your options.
To sum up
- When you take out a home loan, you generally have to choose between a fixed interest rate or variable interest rate.
- A fixed interest rate home loan is one where your interest rate is locked in for a certain period, so your loan repayments remain the same over the fixed rate term.
- With a variable interest rate home loan, the interest rate attached to the loan can change, so your required repayment may increase if rates go up; it may decrease if interest rates decrease.
- There are pros and cons to each type of loan. Consider which option is best for you.
- You can choose to split your loan between the two options.