- Converting a home loan to a fixed interest rate may be an attractive option in a rising interest rate environment
- But it can penalise borrowers if interest rates fall, leaving them paying a higher rate than variable rates available on the market
- Knowing when to fix your interest rate and for how long can be a gamble, but may provide some borrowers with financial certainty
Whether or not to fix your home loan rate can be a difficult call. For the risk averse, locking in a set mortgage repayment might seem an attractive way to protect yourself from rate increases. But it's still a gamble - fixing just before variable rates start to fall may see you pay much more interest than you otherwise would have.
As any sensible punter will tell you, more information increases the likelihood of success. Here's what to know before choosing between a fixed or variable interest rate.
When should you fix your home loan interest rate?
For many mortgage holders, choosing between variable and fixed rates is all about anticipating future movements of the RBA cash rate.
Fixing while rates are bottomed out can lock in lower repayments, insulating borrowers from increases as variable rates start climbing.
Rate fixing in action
You only need to look back to 2021 - the most recent peak in the popularity of fixed-rate home loans in Australia. From June to September, more than 45% of new mortgages had fixed rates (10-15% is the norm). At the time, the RBA cash rate was at an all-time low of 0.10%.
Our analysis suggests that if a borrower with a $540,000 home loan fixed their rate at 2.00% for three years or more in April 2021, then after three years they would theoretically be $24,000 better off than if they'd remained on a variable rate.
Some borrowers also value the certainty that fixed rates can offer. Locking in your mortgage repayments for a fixed period allows you to budget more accurately and better plan your financial future.
See also: How to choose between a fixed-rate or variable-rate home loan
When not to fix your home loan interest rate
Of course, the flipside to fixing is that if interest rates go down, you miss out on your repayments falling.
Bad time for fixers
Take a borrower who fixed their rate in early 2008, just before the Global Financial Crisis, with the cash rate at 7.25%. There were no indicators at the time that rates would be cut by 4.25% by April 2009, but that's exactly what happened.
Paying a fixed home loan rate as interest rates fall can be difficult to watch. But if you want to get out of your fixed-rate deal to take advantage of lower rates on the market, you will very likely face break costs.
These are the fees you pay for ending a fixed-rate contract early to refinance, even if you're sticking with the same lender. Sometimes break costs can amount to thousands of dollars.
Fixed-rate loans also tend not to come with as many extra features. Offset accounts, for example, are more common on variable-rate loans. Fixed-rate mortgages can also be more restrictive in accepting extra repayments and/or allowing you to pay off your loan earlier.
"The people I see fix and never regret it are the ones who value certainty over the chance of saving a few dollars. If you’re a young family on one income, or you’re running a business with enough unknowns already, knowing exactly what comes out of your account every month is worth a lot. Fixing makes sense when you genuinely think rates are heading up and you want today’s number locked in before the banks move. But be honest with yourself first: are you staying put? Are your finances steady? Are you done with big changes for a year or two? If the answer’s yes, fixing is often the smart, boring decision. And boring is underrated. But weigh the features, the comparison rate, and whether splitting the loan part fixed, part variable gives you the best of both worlds. You don't always have to pick a side."
Pros & cons of fixing your home loan rate
Here's a summary of the yeas and nays of fixing your home loan interest rate.
Pros
- Payment certainty: Knowing exactly what your home loan repayments are going to be for a set period can help with budgeting and financial planning
- Mortgage stress protection: A fixed-rate home loan shields borrowers from higher repayments should interest rates rise
Cons
- Missing out on rate cuts: When interest rates fall, you will continue paying your set fixed-rate repayment regardless
- Paying higher rates up front: Switching to a fixed interest rate will often see you paying a higher interest rate initially than the variable rate on offer. This is because lenders tend to price fixed rates higher to build in some cushioning.
- Not as flexible: Many fixed-rate loans often put a cap on extra payments and don't typically come with offset facilities
- Subject to break fees: If you change your mind about fixing your interest rate and want to switch back to a variable rate - or refinance with another lender - you could be up for a considerable sum in break fees
Split home loans: a bet each way
If you can't make up your mind about whether or not to fix, a split home loan lets you fix a portion of the loan while the rest remains at a variable rate.
A split loan essentially separates the loan balance into two accounts - one is charged a fixed interest rate, the other variable. Many lenders allow borrowers to split the loan any way they wish - 50/50, 60/40, 80/20, etc.
Splitting your home loan can allow you to hedge your bets. Should rates go down, your repayments will still decrease on the variable portion of the loan. If they go up, your repayments won't go up by quite as much as a portion of the loan will be on an unchanged fixed rate.
But just as those benefits apply, it also means you won't reap them to the same extent as they'll just apply to one portion of your loan balance.
What to consider before fixing your home loan
There are a few variables to keep in mind if you're considering fixing your home loan.
1. Cash rate movement
Fixing your home loan is not that different from wagering a bet with your lender over whether interest rates are likely to go up or not. If you strongly believe variable rates are set to increase in the near future, this might be the impetus to lock in.
Also, keep in mind that lenders are playing the same game, pricing in future rate movements. If variable rates are low but expected to go up before too long, you might find fixed rates to be higher than variable rates. On the other hand, if variable rates are high but forecast to go down, fixed rates might be lower.
2. Break fees
The cost to break a fixed loan is typically much higher than on variable rates. Break fee calculations depend on a few factors including interest rate differentials and what time remains on the fixed term. They can run into the thousands of dollars.
It means if you decide to fix your rate but later decide you want to refinance, you'll probably be stung with a hefty penalty. If you want to keep your options open, fixing can be may not be the best for you.
3. Revert rate
Before fixing, you should investigate what the revert rate might be on your loan once the fixed term expires. Don't assume the lender will revert your loan to the bank's lowest available variable rate once the fixed-rate period ends. Instead, the lender will probably just put you back on whatever their standard variable rate is - which can be considerably higher than their lowest rates.
See also: Why revert rates are important
4. Fixed term
If you decide to fix your rate, the next decision is how long a fixed period you're after. In Australia, fixed rate terms are generally between one and five years (although a few lenders offer longer terms).
Different fixed term lengths can have different rates which lenders set according to where they believe rates may be in those rough time periods. Of course, even experts find predicting interest rates a challenge. Longer terms will generally come with a bit of an uncertainty premium.
See also: Home loans with fixed-rate terms of one to three years
See also: Home loans with fixed-rate terms longer than 5 years
How long should you fix your home loan for?
There are a few variables involved with choosing the ideal fixed-rate term length. For many borrowers, it will depend why you're fixing your rate in the first place.
These are among the most important considerations:
Future of interest rates
One of the most obvious reasons to fix your home loan rate is because you're anticipating upcoming increases in the cash rate. Fixing you can inoculate you from seeing your mortgage repayments climb if/when the RBA increases the official cash rate.
If you're confident in your ability to foresee which way interest rates may head over the next couple of years, it's be wise to factor this in to choosing your fixed term. For example, you might expect rates will be consistent for an extended period, say 18 months, before they start falling.
In this scenario, a low-rate loan fixed for one year might make more sense than fixing for longer and potentially missing out if variable rates start to come down before your fixed term expires.
Financial goals
Beyond the gamble on interest rates, some borrowers are attracted to fixed rates because of the stability consistent repayments can provide. A longer-term fixed rate can allow you to reliably plan your finances further into the future, which can be particularly useful if you have another long-term saving goal such as a holiday, a wedding or buying another property.
Future plans
Your plans for the next few years should also factor into your considerations when choosing how long to fix for.
One of the major drawbacks to fixed-rate home loans are the extra break costs you'll pay if you discharge the loan before time so it pays (literally) to have an overarching financial strategy.
Longer fixed terms are often better suited to borrowers who are reasonably certain about how the next few years will play out. Say you've got young children and are mortgaging a family home you intend to live in until they are all finished school, you might be pretty confident you won't decide to refinance to an investment home loan in the next couple of years. In that case, a longer-term fixed rate might make sense.
Meanwhile, borrowers thinking of selling their home or refinancing in the near future might wish to avoid longer fixed-rate terms to prevent incurring large break costs.
Savings.com.au's two cents
In his best-selling book The Barefoot Investor, Scott Pape had this to say about fixed-rate home loans:
"The only reason you would fix your rate is if you're really struggling and you want the security of fixed repayments, but for everyone else it's too much of a gamble."
Most people choose to fix their rates because they need financial certainty. For others, it's about trying to beat the banks at their own game and secure the lowest possible rate.
Whatever your motivation is for considering a fixed home loan, you should first consider your long-term financial needs and goals, do your research, and make sure you understand the advantages, disadvantages and long-term implications of fixing.
Fixing your home loan interest rate certainly doesn't guarantee that you'll save money. It may save you money if interest rates rise during a fixed-rate period but fixing may also cost you money if interest rates fall. There are many factors you'll need to take into consideration, including how much you value flexibility, whether you are seeking certainty with your home loan repayments, your financial plans, and what the future movements of the cash rate may be. Some of these variables are in your control but very few people - even 'experts' - can accurately predict cash rate movements. You need to strike a balance between what's best for your circumstances and what the broader economy may do. The decision to fix a home loan will always be something of a gamble - for both borrower and lender. The majority of fixed-rate home loans do not come with offset accounts. Many lenders will also restrict the amount of extra payments borrowers can make while the loan is in a fixed-rate period. In fact, making extra payments or paying out a fixed-rate loan early typically comes with a penalty that may cost thousands. But this doesn't apply to all lenders. There are a small handful on the market that offer 100% offset accounts during fixed terms while others may offer partial offsets or limit the amount of money you can keep in a linked offset. Many lenders routinely offer redraw facilities on fixed-rate loans but the amount permitted in redraw is also generally restricted. If you want to keep a substantial sum in an offset account and use it to optimise interest savings, variable-rate loans generally provide the best vehicle for doing this. A split loan can be a middle path if you're choosing between fixing your home loan and keeping it on a variable rate. Splitting your loan into fixed-rate and variable-rate portions can provide 'the best of both worlds' allowing you to hedge your bets against the full effect of future interest rate movements and also provide a balance between stability and flexibility. This strategy can see the fixed-rate part of your loan cushion you from future interest rate increases but it can also mean you won't get the full benefit of interest rates falling below your fixed rate. Splitting your loan will still allow you to make extra payments, retain an offset account, and even pay out your loan early - all of which are permitted with variable-rate loans but are generally restricted under fixed-rate conditions. Split home loans can give you a foot in both camps. Some fixed-rate home loans may offer a 'rate lock' feature. This essentially guarantees your interest rate will not rise between the time you apply for your fixed-rate home loan and when the loan settles. It can be particularly handy in a period where interest rates look set to head higher and you're worried the fixed rate you're applying for won't be the rate when you have to start making repayments. Settlement periods for properties can be between 30 to 90 days so a rate lock acts as insurance you'll get the rate you're signing up for. Lenders will generally charge a rate lock fee, either levied as a flat fee of between $300 and $1,000 or a percentage of the loan amount, generally between 0.10% to 0.15%. A rate lock can be worth it if you're signing up for a loan on the cusp of a cash rate upcycle. The lock generally applies for between 60-90 days. If your loan settlement takes longer than that, you may need to pay another lock fee. If rates go down during the settlement period, a lender will generally keep your lock fee but most will likely give you the lower rate anyway. A fixed-rate 'cliff' refers to the financial shock some borrowers experience when their fixed-rate period expires and their home loan reverts to a much higher variable rate. Fixed-rate terms generally vary between one to five years (although some lenders offer longer periods). Most fixed-rate loans will revert to the lender's standard variable or reference rate which can be considerably higher than its other advertised variable home loan rates. Before your fixed-rate period ends, it is important to consider your options and start negotiating with your lender. You may choose: When you sign up to a fixed-rate period, you'll need to be prepared for what may happen at the end of it. If interest rates rise considerably during your fixed-rate term, it can be difficult to avoid the fixed-rate cliff but you may be able to cushion the fall. This can mean putting money aside to provide a buffer from the financial shock of higher repayments or looking to refinance your home loan to a more manageable repayment schedule when the fixed-rate period ends.Frequently Asked Questions