Fixed or variable? Crunch the numbers

With lenders engaging in serious competition on the fixed rate home loan front, it is timely to consider how this type of loan stacks up against the traditional variable home loan.

The latest Australian Bureau of Statistics (ABS) housing finance data shows that although fixed rate home loans account for a relatively small portion of all new home loans, they have increased in popularity recently. Compared to July 2010, ABS data shows that 75 percent more fixed home loans were financed during July 2011.

One reason for this may be the competitive rates on offer, with RateCity CEO Damian Smith noting that three-year fixed rates are now below standard variable rates on average. Indeed, a recent RateCity study found that more than 70 percent of lenders have dropped some or all of their fixed rates since the beginning of August 2011, including the four major banks.

As a result, borrowers now have many attractive fixed rate home loan options. For instance, at the time of writing, AMP offered 6.39 percent for three year fixed home loans, while ME Bank and credit union ECU Australia are offering three year fixed rates at 6.35 percent. On the other side of the ledger, one of the best variable home loan rates currently available are from loans.com.au (6.58 percent), and Illawarra Home Loans (6.68 percent).

But while it might seem like simple maths to choose the fixed rate over the variable, it is important to consider all the elements of each loan. On a 25-year $250,000 loan, it would appear that the AMP fixed rate of 6.29 percent will save you plenty over Illawarra’s 6.68 percent. However, after taking into account the ‘revert rate’ on the fixed home loan — the rate that applies once the three year fixed period is over – and any fees, the difference between AMP and Illawarra is $2500 over the life of the loan, based on today’s figures. The savings might not be as significant as anticipated, but it’s still a saving all the same.

There are other issues with fixed rates too. For instance, if interest rates fall, you’ll be stuck paying a higher interest rate. On the other hand, fixed rates loans can be just the tonic for people who want interest rate certainty for budgeting purposes and financial peace of mind – real estate investors can find this security useful.

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