Choosing between a fixed or variable rate home loan is a common dilemma for many borrowers.
We look at what they are and outline some of the key advantages and disadvantages of both to help you decide which option is suitable for you.
What’s in this guide?
- What is a fixed rate home loan?
- What is a variable rate home loan?
- Splitting loan between fixed and variable rates
- How to choose between a fixed and variable rate
- Compare and save on variable rate home loans
- Compare and save on fixed rate home loans
- Frequently asked questions
Differences between fixed and variable home loans
What is a fixed rate home loan?
A fixed interest rate home loan is a home loan with the option to lock in (or ‘fix’) your interest rate for a set period of time (usually between one and five years). One of the main advantages of this is cash-flow certainty. By knowing exactly what your repayments will be, you’ll be able to plan ahead and budget for the future. This factor often makes fixed rate home loans very popular for investors over the first 2-3 years that they own a property for.
Another reason why a fixed rate may be a good option for you is that any interest rate rises won’t affect the amount of interest you will have to pay. However, if interest rates drop, you might be paying more in interest than someone who has a variable rate home loan.
It’s also important to note that often additional loan repayments are not allowed with fixed-rate loans (or only allowed if you pay a fee). Because of this, the ability to redraw is also frequently not offered on a fixed rate loan, effectively reducing the flexibility of the loan.
What is a variable rate home loan?
A variable rate home loan is a home loan where your interest rate will move (or ‘vary’) with changes to the market. This means your interest rate can rise or fall over the term of your loan.
Variable home loans also have appealing features like the ability to make extra repayments (often at no extra cost) to help you pay off your loan sooner and save you interest. Another advantage can include unlimited redraws (where you ‘draw’ back out the extra repayments you made).
Variable rate loans are more uncertain than fixed interest rate loans. This can make budgeting for your interest payments more difficult because you have to take into account potential rate rises. If you aren’t prepared, you could have trouble keeping up with repayments.
Can I split my loan?
A popular home loan option is to split your loan between fixed and variable. This allows you to lock in a fixed interest rate for up to 5 years on a portion of your loan, while the remainder is on a variable rate. Effectively, this can help you ‘hedge your bets’ on an interest rate rise or cut, minimising the risks associated with interest rate movements. At the end of the fixed rate period, you may have the choice of fixing that portion again (at the current market rate for fixed interest) or simply letting it revert to a variable interest rate. Keep in mind that the variable rate it reverts to may be higher than the variable rate you’re already paying on the other portion of the loan.
Fixing a home loan rate: Things to consider
While having a fixed interest rate can be attractive to those who value stability and are averse to risk (namely, the risk of rising interest rates), choosing to take out a fixed rate can actually be a bit of a gamble, ironically.
Fixed-rate mortgages have a number of potential traps, so there are a few things you should consider before applying for one:
1. Could interest rates fall?
If you’re tempted by some pretty low fixed home loan interest rates, keep in mind that they may be low for a reason. A 2-year fixed-rate of 3.00% p.a. may look pretty good now, but it may not look so good in six months’ time where there may be variable rates on offer for 2.50% p.a. or less.
When lenders think there’s a strong chance interest rates will fall in the near future, many try to tempt borrowers into taking out fixed-rates, because that way there’s fewer customers for them to pass on future rate cuts to. So essentially, fixing your rate is like making a bet with your lender over whether market interest rates are going up or down. If rates rise, you win by avoiding a rate hike. If rates fall, you miss out on a rate cut, so the lender wins.
But the lender may have the better odds of winning the bet, because the smarty-pants analysts and economists in their loan pricing teams will have all the fancy graphs and data at their disposal to help them accurately forecast the market and set fixed rates accordingly.
2. Break fees
Really ask yourself whether you’ll be able to commit to the entirety of the fixed term. Because should you take out a fixed loan then later decide to refinance to a variable rate because you’re sick of paying a fixed rate that’s much higher than the low variable rates that all your mates are enjoying, you’ll be slapped with a break fee, which can amount to thousands of dollars. This also applies if you want to pay off the loan before the end of the fixed period, such as if you decided to sell your house.
3. Revert rates
At the end of the fixed-rate period, don’t expect the lender to automatically switch your loan to one of its lowest variable rates. Chances are your loan will revert to the lender’s standard variable rate, which can be over 200 basis points higher than some of its lowest rates. You’ll then probably want to refinance to a lower rate – a process which comes at a cost.
Fixed vs variable home loan: how to choose
Trying to predict home loan interest rates can be a risky business, but in effect, every homeowner is doing this whether they decide on a variable interest rate or fixed. If you’re new to the market or worried about interest rates going up sooner rather than later, then fixing all or a portion of your loan could be a good strategy.
A quick look at what’s on offer in the market for 3-year fixed rates at the time of writing shows that the premium you’d pay to fix your rate could be around 25 to 50 basis points (0.25% to 0.50% points).
Home loans depend on your individual circumstances, attitudes and motivations. If you’re new to the market and don’t feel comfortable taking any risks then you may want to consider choosing a fixed rate home loan, much like many new property investors do for the first several years of their investment property loan.
If you’re more confident with interest rates and are happy to be paying what the great majority of other lenders are paying (relatively speaking), you may find a variable rate home loan is more suited to your needs.
Compare & save on variable home loans
Base criteria of: a $400,000 loan amount, variable, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. The product and rate must be clearly published on the Product Provider’s web site. Introductory rate products were not considered for selection. Monthly repayments were calculated based on the selected products’ advertised rates, applied to a $400,000 loan with a 30-year loan term. Rates correct as at 03 April 2020. View disclaimer.
Compare & save on fixed home loans
Base criteria of: a $400,000 loan amount, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. The product and rate must be clearly published on the product provider’s web site. Introductory rate products were not considered for selection. Monthly repayments were calculated based on the selected products’ advertised rates, applied to a $400,000 loan with a 30-year loan term. Rates correct as at 03 April 2020. View disclaimer.
Frequently asked questions
Just about all lenders in Australia offer both fixed and variable-rate mortgages. The most common fixed-rate mortgages in Australia are one-year to five-year fixed rate terms, with few lenders offering 10-year fixed-rate terms, and even fewer offering 15-year terms. A 30-year fixed-rate mortgage is not available in Australia.
Not necessarily. As variable home loan rates can rise or fall depending on what’s happening in the market, variable rates may not always be higher than a fixed rate. You’ll find that the average variable rate is actually usually lower than the average fixed rate.
Variable mortgage rates may rise or fall depending on what the market is doing and at what rate the RBA has set the official cash rate.
If the cash rate goes up, lenders typically increase interest rates – raising your minimum required recurring repayment. Conversely, if the cash rate goes down, lenders typically lower interest rates, lowering your minimum required repayment, although your repayment amount might not change automatically (you may have to contact your lender to lower it).
Switching your mortgage from a variable-rate to a fixed rate can be relatively simple, whereas switching from fixed to variable (before the end of the fixed term) can be much more of a challenge given you will likely face expensive break costs.
There may be a few reasons why there aren’t 30-year fixed-rate mortgages in Australia. One simple reason might be because there’s a lack of demand for them. Most Aussies are happy to take out variable-rate mortgages, knowing that variable rates often have lower interest rates than fixed rates. A slightly more complicated reason is that Australia’s debt market is not developed enough to allow lenders to easily on-sell bundles of 30-year fixed mortgages to investors, so lenders are generally unwilling to offer them because it means they are likely to be stuck with 30-year fixed loans on their balance sheet.
A fixed rate home loan is a legal contract guaranteeing your mortgage will be charged a fixed rate of interest for a specified amount of time. If you decide to break a fixed rate home loan contract, your existing lender must be compensated for any loss they incur. You will have to pay two fees: a break fee (which can be very expensive) and a discharge fee, which is usually a few hundred dollars.
The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:
- The big four banks are: ANZ, CBA, NAB and Westpac
- The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2019. They are (in descending order): Credit Union Australia, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
- The larger non-bank lenders are those who (in 2019) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site.
In the interests of full disclosure, Savings.com.au and loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.
*The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate.
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