The fixed versus variable home loan debate

Choosing between variable, fixed and split rate home loans can feel like playing a game of rock, paper, scissors – all about predicting what’s likely to happen next.

With interest rates continuing to rise for owner-occupier and investor home loans, borrowers may be feeling uncertain as to which type of loan they should commit to. Choosing between variable and fixed interest rates can be difficult, but there are ways to get ahead.

What is a fixed home loan?

A fixed home loan allows you to lock in an interest rate on your mortgage for a length of time to enjoy greater stability and simpler budgeting in your personal finances. Most lenders will offer fixed periods between 1-5 years, however some do offer fixed home loans of up to 10 years.

 Fixed interest rates give you certainty; if you can afford the repayments today, you can afford them next year (assuming your circumstances remain the same). It’s this peace of mind that appeals to many fixed rate borrowers because their repayments stay the same whether rates fall, rise or stay the same.

What is a variable home loan?

Fixed home loans can be frustrating if you lock in a rate before variable rates drop, because exiting a fixed-rate mortgage can be costly.  Most borrowers stick with the variable rate rollercoaster, which keeps things flexible – allowing for extra repayments, for instance.

A variable home loan usually starts with a lower home loan rate offered by the bank, which fluctuates depending on the cash rate determined by the Reserve Bank of Australia (RBA).

Is it worth the risk?

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In recent weeks, dozens of lenders have increased interest rates for owner-occupied and investor home loans, including the big-four banks.

This has followed changes to regulations made by the Australian Prudential Regulation Authority (APRA), including limiting interest-only loans to 30% of all new loans supplied by banks and lenders. The RBA has responded to changes in regulations and rising interest rates by holding the cash rate at an historically low 1.5%.

A recent RateCity survey has shown that 1 in 10 people who have refinanced their home loan in the past two years switched from a variable to a fixed home loan with the same bank.

Borrowers’ best options

While interest rates can make a substantial difference to your repayments and the total interest you pay on your home loan, the past has proven it’s very hard to predict which option will perform better.

Fixing in October 2005 would have saved borrowers 15%, or around $12,200 compared to variable over the following three years. Fixing a home loan rate in September 1991 would have cost a borrower an extra 30%, or $29,800, over the next three years.

Typically, when the gap between fixed and variable rates widens due to either an increase in variable rates or a decrease in fixed or both, it could be the right time to fix.

Another good time would be if fixed rates were not much higher than the average basic variable rate. For example, if the average basic variable rate was 4.97%, and some lenders were offering three-year fixed loans at 5.1%, with a difference between the two of only 13 basis points, it could be worth fixing. 

However, most Aussies tend to ‘panic fix’ when rates are at the highest. For example, more than 25% of new loans were fixed in March 2008 when the RBA cash rate was at a peak at 7.25%. When rates fell to 3% a year later, only 4% of new loans were fixed. 

Ultimately, choosing between a fixed or variable rate is still a personal choice. It is important that you factor in whether you can afford at least a 2% rate increase no matter what type of loan you decide. 

Tips to consider before fixing

What are the break costs?

Lenders can charge borrowers fees when you make extra repayments on a fixed home loan. Most will allow you to pay a small extra amount off your mortgage without being charged. but if you go over this amount, or fully pay off your loan ahead of schedule, you may be charged break costs. As of July 2011, variable mortgages have no early repayment penalties or exit fees, however fixed rate break costs and discharge fees still apply.

 Track your bank’s interest rates

If your loan’s fixed term is coming to completion, it is wise to monitor it well ahead of time and discuss your best options with your bank before it finishes. You may want to fix again or revert to a variable rate, depending on whether you believe rates will continue to rise or fall.

 Consider taking out a split loan 

If you still can’t decide, perhaps a split loan is for you. Having half your loan in a variable account could allow for flexibility, while the other half of your loan remains secured at the fixed rate.

 Pros / Cons of fixed rate 

Pros
  • Protected against raising interest rates
  • Protected against cash rate fluctuations
  • Set an accurate budget
Cons
  • If lenders drop rates you’re stuck paying more
  • Less flexibility to make extra payments
  • Typically have expensive break fees
  • Loan may take longer to pay off, so you’ll pay more interest

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What is the difference between fixed, variable and split rates?

Fixed rate

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

Variable rate

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

Split rates home loans

A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.

What is a fixed home loan?

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

What is a variable home loan?

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

What is a split home loan?

A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.

What is the difference between a fixed rate and variable rate?

A variable rate can fluctuate over the life of a loan as determined by your lender. While the rate is broadly reflective of market conditions, including the Reserve Bank’s cash rate, it is by no means the sole determining factor in your bank’s decision-making process.

A fixed rate is one which is set for a period of time, regardless of market fluctuations. Fixed rates can be as short as one year or as long as 15 years however after this time it will revert to a variable rate, unless you negotiate with your bank to enter into another fixed term agreement

Variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts however fixed rates do offer customers a level of security by knowing exactly how much they need to set aside each month.

What is a standard variable rate (SVR)?

The standard variable rate (SVR) is the interest rate a lender applies to their standard home loan. It is a variable interest rate which is normally used as a benchmark from which they price their other variable rate home loan products.

A standard variable rate home loan typically includes most, if not all the features the lender has on offer, such as an offset account, but it often comes with a higher interest rate attached than their most ‘basic’ product on offer (usually referred to as their basic variable rate mortgage).

What is a comparison rate?

The comparison rate is a more inclusive way of comparing home loans that factors in not only on the interest rate but also the majority of upfront and ongoing charges that add to the total cost of a home loan.

The rate is calculated using an industry-wide formula based on a $150,000 loan over a 25-year period and includes things like revert rates after an introductory or fixed rate period, application fees and monthly account keeping fees.

In Australia, all lenders are required by law to publish the comparison rate alongside their advertised rate so people can compare products easily.

Who has the best home loan?

Determining who has the ‘best’ home loan really does depend on your own personal circumstances and requirements. It may be tempting to judge a loan merely on the interest rate but there can be added value in the extras on offer, such as offset and redraw facilities, that aren’t available with all low rate loans.

To determine which loan is the best for you, think about whether you would prefer the consistency of a fixed loan or the flexibility and potential benefits of a variable loan. Then determine which features will be necessary throughout the life of your loan. Thirdly, consider how much you are willing to pay in fees for the loan you want. Once you find the perfect combination of these three elements you are on your way to determining the best loan for you. 

What is the best interest rate for a mortgage?

The fastest way to find out what the lowest interest rates on the market are is to use a comparison website.

While a low interest rate is highly preferable, it is not the only factor that will determine whether a particular loan is right for you.

Loans with low interest rates can often include hidden catches, such as high fees or a period of low rates which jumps up after the introductory period has ended.

To work out the best value for money, have a look at a loan’s comparison rate and read the fine print to get across all the fees and charges that you could be theoretically charged over the life of the loan.

What is a guarantor?

A guarantor is someone who provides a legally binding promise that they will pay off a mortgage if the principal borrower fails to do so.

Often, guarantors are parents in a solid financial position, while the principal borrower is a child in a weaker financial position who is struggling to enter the property market.

Lenders usually regard borrowers as less risky when they have a guarantor – and therefore may charge lower interest rates or even approve mortgages they would have otherwise rejected.

However, if the borrower falls behind on their repayments, the lender might chase the guarantor for payment. In some circumstances, the lender might even seize and sell the guarantor’s property to recoup their money.

How do I take out a low-deposit home loan?

If you want to take out a low-deposit home loan, it might be a good idea to consult a mortgage broker who can give you professional financial advice and organise the mortgage for you.

Another way to take out a low-deposit home loan is to do your own research with a comparison website like RateCity. Once you’ve identified your preferred mortgage, you can apply through RateCity or go direct to the lender.

What is breach of contract?

A failure to follow all or part of a contract or breaking the conditions of a contract without any legal excuse. A breach of contract can be material, minor, actual or anticipatory, depending on the severity of the breaches and their material impact.

What happens when you default on your mortgage?

A mortgage default occurs when you are 90 days or more behind on your mortgage repayments. Late repayments will often incur a late fee on top of the amount owed which will continue to gather interest along with the remaining principal amount.

If you do default on a mortgage repayment you should try and catch up in next month’s payment. If this isn’t possible, and missing payments is going to become a regular issue, you need to contact your lender as soon as possible to organise an alternative payment schedule and discuss further options.

You may also want to talk to a financial counsellor.