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The fixed versus variable home loan debate

Vidhu Bajaj avatar
Vidhu Bajaj
- 6 min read
The fixed versus variable home loan debate

When it comes to home loans, an important decision you must make is choosing between a fixed or a variable interest rate. Each option has its pros and cons, and the right one for you depends on your preferences and financial circumstances.

A fixed rate loan means that the interest rate on your loan remains constant for a specified period, typically between one to five years. This can provide stability and predictability in your mortgage repayments, making it easier to budget. However, if the interest rates happen to drop during your fixed term, you won’t benefit from the lower rates. Similarly, your interest rate will remain unaffected by any hikes during the fixed rate period.

In contrast, a variable rate home loan has an interest rate that could change over time in response to market conditions. Variable rate home loans often follow the changes in the cash rate set by the Reserve Bank of Australia (RBA).

When the RBA raises the cash rate, variable interest rates on home loans are likely to rise. Similarly, when the RBA reduces the cash rate, lenders may follow suit and reduce their variable rates. Besides enabling borrowers to benefit from potential rate cuts, variable rate home loans may offer more flexibility compared to some fixed rate home loans in terms of the features offered.

Fixed vs variable rate loans: how they differ

 Fixed rate home loans

Variable rate home loans 

Interest rateThe interest rate on a fixed rate home loan remains constant throughout a specific term, which may last for between one to five years.The interest rate on a variable rate home loan may fluctuate periodically in response to market conditions. 
Monthly repaymentsRepayment size is unlikely to change during the fixed period. Some borrowers may prefer such stability for easier budgeting.Borrowers may experience fluctuations in their monthly repayments, which could be higher or lower, depending on the interest rate determined by the lender.
Protection against rate hikesFixing the interest rate could shield borrowers from potential rate hikes during the fixed period. However, they may find their repayment size jump considerably at the end of the fixed period, depending on the ongoing rate established by the lender.A variable rate could expose borrowers to the risk of interest rate increases. Monthly repayments on a loan could rise if market rates go up.  However, borrowers can also enjoy reduced repayments if interest rates are lowered.
Prepayment penaltiesSome fixed-rate loans may have penalties for early repayment or refinancing before the fixed term expires, limiting flexibility.Variable rate loans typically offer more flexibility for extra repayments, and refinancing without significant penalties.
SuitabilityBorrowers who prefer stability in their budget may prefer fixed rate home loans. Borrowers may also consider fixed rate home loans when they suspect interest rates may rise. However, fixing the interest rate on a loan isn’t a guaranteed way to avoid higher interest.Borrowers who prioritise features and flexibility may prefer a variable rate loan, even though some fixed rate loans do offer these features. Borrowers may also consider a variable rate loan if they think interest rates may fall, and they aren’t worried about fluctuating interest rates.

Fixed or variable, what could be the best choice for borrowers?

The interest rate on your loan can make a substantial difference to your repayments and overall interest expenses. However, predicting which option, fixed or variable, will perform better is tricky to predict.

In general, fixing the rate on a mortgage could be beneficial when you expect that interest rates are likely to rise in the near future. Some borrowers may also consider fixing when the difference between fixed and variable rates is relatively small, or just when this gap begins to widen - either due to an increase in variable rates or a decrease in fixed or both. However, it’s essential to acknowledge that predicting interest rate movements is tricky. 

For example, during previous rate-hiking cycles, many borrowers "panic fixed" when rates were at their highest. In March 2008, when the RBA cash rate hit 7.25%, more than 25% of new loans were fixed. Yet, when rates dropped to 3% a year later, only 4% of new loans were fixed.

In the current scenario, some of the major banks have reduced their fixed rates, leading to the speculation that the interest rates may have peaked. Still, mostborrowers are unlikely to choose a fixed rate over a variable. According to RateCity Research Director Sally Tindall, “Most borrowers are going to keep their powder dry by sticking with a variable rate until they see where the cash rate lands.

Generally speaking, while fixing your home loan can provide stability, it's crucial to approach this decision with caution. Make sure to weigh the potential benefits against the risks and make a decision that aligns with your financial circumstances and risk tolerance. Consider shopping around and doing what’s better for your financial situation. 

The timing of rate cycles can be elusive and it isn’t easy to predict whether a fixed or a variable rate will perform better. If you can’t decide between fixed and variable rate home loans or you’re looking for a middle path, a split rate home loan may be worth exploring.

As the name suggests, a split rate home loan allows you to ‘split’ the interest charged on your home loan into a fixed rate portion and a variable rate portion. However, this does not have to be a 50/50 split. You could opt for any ratio, say a 60% variable home loan and 40% fixed home loan, for example. 

With a split rate home loan, you could potentially secure some of your mortgage repayments from rate fluctuations. If interest rates rise, you won’t feel the impact of a rate hike as significantly as if you were on a 100% variable loan. Further, you’ll still stand to benefit to an extent if your lender were to reduce the variable rate on your home loan. 

But not every home loan offers the ability to split your rate, so consider shopping around and checking all the terms and conditions before applying. Keep in mind that there is more to a home loan than the interest rate you pay. You would also want to compare the fees, features and any other benefits associated with a loan.

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Product database updated 14 Apr, 2024

This article was reviewed by Personal Finance Editor Peter Terlato before it was published as part of RateCity's Fact Check process.