Fixed or Variable Interest Rate: Which is right for you?

Fixed or Variable Interest Rate: Which is right for you?

Kathryn Lee - 2 Apr, 2019

Choosing between fixed-rate and variable is often the first decision of many to plague first home buyers. No one can predict the future – nor what will happen to the economy – but some home loan features can be safer (or better suited) than others.

As always, it pays to do your research; starting here. Beginning your home loan journey with the right interest rate product can mean the difference of hundreds – or even thousands – of dollars. Join us as we discuss the who, what, where and why of interest rates, and help shed some light on what product might be best for you.

What are fixed interest rates?

A fixed-rate mortgage is just what its name suggests, fixed. For as long as the contract term’s stipulate, a fixed-rate mortgage’s interest rate will not change, no matter what is happening to the market. This period is typically 1 to 5 years.

This rate type can be an excellent way to go if you want to know exactly what your future repayments will be. A fixed-rate can also allow you to better budget and help ease worries, especially if money is tight.

The downside of a fixed rate home loan is that if interest rates drop, you will not be able to take advantage of them – that is, unless you decide to leave your agreement early. But be warned: fixed-rate home loans often have large fees associated with ending the agreement early, which may well outweigh the benefits switching to a variable rate.

This type of loan can also have restrictions on making extra repayments. Those who are likely to come into extra income over the fixed period might be better off considering other options.

What are variable interest rates?

The interest rate on a variable loan is ever-changing. Usually responding to changes in the cash rate, the interest rate of a variable home loan product is recalculated frequently, making it more unpredictable than a fixed rate.

If the cash rate drops, variable interest rates will often follow suit, benefiting the mortgage holder. On the other hand, if the cash rate increases variable interest rate holders can be slapped with higher rates.

Despite this, variable rates can be good for those who want the flexibility to refinance or change home loan products in the future since there are often less restrictions for leaving the agreement.

But be warned. In some cases, lenders will also increase variable interest rates even if there hasn’t been any change to the cash rate, making these loans somewhat unpredictable. For this reason, this loan type might not be suited to those who need certainty.

How to choose the right interest rate type?

What are the features of variable interest rates?

  • Choice of payment options. Often variable interest rate home loans will give you more repayment options, letting you choose whether you pay principal and interest or whether you pay interest only.
  • The possibility of extra repayments. Variable rate home loans often let borrowers make extra repayments, letting mortgage holders take advantage of good economic times by contributing more to pay off their loan, and thus reducing total interest paid.
  • Offset accounts and redraw facilities. Having an offset account is like having a savings account, only its value can be subtracted from your principal loan and reduce the interest you have to pay. Similarly, a redraw facility allows you to make extra repayments which you can then withdraw in case you need them back.
  • Split loans. Many variable interest rate products also let you ‘split’ the loan, allowing you to make part of your product fixed and the other variable. This can offer more protection in case of a turn in the mortgage market.

What is the comparison rate?

The comparison rate is not a home loan product but rather, a tool for comparing the interest rate against other home loan interest rates on offer. It takes into consideration fees and charges associated with the product and calculates a new ‘comparative’ number which gives a truer indication of the product’s value.

For example, you may come across a startlingly low fixed-rate home loan product but upon further reading you may realise the comparison rate is much higher, indicating the product is made up of a multitude of different fees to consider.

Always check the comparison rate to help make sure you are getting a good deal.

Is a variable rate home loan always higher than a fixed rate?

Whether or not a fixed rate home loan or a variable rate home loan is higher all depends on the market.

In conditions where the cash rate is expected to drop, fixed-rate home loans will often be lower to entice consumers to ‘sign on’ and forgo the chance of a lower future variable rate.

However, when the cash rate is predicted to rise, lenders usually offer variable home loans at a better rate. This is to entice consumers away from the somewhat safer option of signing onto a fixed rate and being ‘protected’ from the future hike.

Related: What are the costs involved in buying a home? The upfront and hidden fees

How often do variable interest rates change?

In an environment with a regularly changing cash rate, there is often constant speculation on a rate rise or drop and at the very least, interest rates can change on a monthly basis. In a more stable environment, the chance of change is dramatically reduced.

What does ‘Principal and interest’ and ‘Interest only’ mean?

“Principal and interest” or “Interest only” refers to whether you are paying off both your loan amount (principal) and interest or whether you are just paying off interest. Those who pay interest only are not actually paying off their mortgage but rather the interest accrued on the loan. This can mean a longer total loan term. Those who pay both principal and interest usually pay off their loans faster.

What is a partially fixed-rate (split loan)?

A partially fixed rate is when a home loan product is both variable and fixed, letting the mortgage holder have the best of both worlds. By splitting the loan into two types, a split loan allows mortgage holders to take advantage of fluctuating interest rates (with some of the loan being under a variable rate) all while having the security of a fixed rate for the remaining loan.

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How will rising interest rates affect mortgage repayments?

Rising interest rates can have negative effects on mortgage holders. While in a low interest rate environment the consumer may have access to more disposable income, and the means to make extra repayments. In a high interest rate environment, customers will often only have enough income to cover living expenses and their loan repayments.

Conventionally, if interest rates are predicted to rise, consumers are usually better off seeking out fixed-rate products to help bring some predictability to their payments, though it is a very personal decision and should be taken as such.

What features should I consider when comparing home loans?

According to there are a few things to consider when picking a home loan:

  • Interest rate (p.a.): What is the advertised interest rate on offer?
  • Comparison rate (p.a.): Is there much difference between the interest rate and comparison rate? If so, this might be a clue that the loan product has hidden charges.
  • Monthly repayment: What will you have to pay each month? Can you afford it?
  • Application fee: Also known as an establishment, up-front or set-up fees, make sure you know how much it is and that you can afford it.
  • Ongoing fees: Usually administered monthly or yearly, be sure to check for any fees and take this into your decision.
  • Loan term: How long will the loan last?
  • Loan features: Does it have an offset account? Redraw facilities? Are these important to you? Are there any extra fees if you choose to use these?

Which option is best for me?

It’s hard to say which home loan option is best since it depends on the current economic climate as well as your individual circumstances. For these reasons, personal research is vital.

When researching home loan options, be sure to not only look at the mortgage types and interest rates but also the comparison rate and any extra features the loan might have.

If you are looking to discuss your home loan options, an eChoice broker can help. eChoice brokers are affiliated with some of Australia’s major lenders and have hundreds of home loan products to choose from.

Related: What is ‘Conditional Approval’ on a home loan?

Can I change my mortgage from variable to fixed?

Yes, it is possible to change between fixed rate and variable (and vice versa) however, it all depends on the product’s terms and conditions.

While it is often easy to switch from variable to fixed just make sure you look out for any associated fees and/or charges.

If you are planning on moving lenders all together (rather than just switching products), this is known as refinancing. This can have its own fees and charges.

How common are fixed-rate mortgages in Australia?

At the time of writing, Australia is experiencing an environment where month-to-month, the cash rate either drops or is predicted to drop but holds. For this reason, variable rate home loans have been more popular since there is anticipation of even lower future rates.

But despite the obvious advantages of a variable mortgage in our current times, it would appear Australians have always favoured this loan type, no matter the conditions.

In 2018 Steve Mickenbecker, the then executive of financial services at Canstar told the ABC that Australians often stick with a variable rate because of their simplicity.

“Most people are on variable loans, as it’s easy to do nothing, and think it’ll work itself out,” he said.

In contrast, Home loan comparison company, Finder, believes it is because more Australians are willing to “have a punt“.

According to ABS data for the month of September 2019, of the Australians who signed up for (or refinanced) an owner-occupier home loan, just 12.4% chose a fixed rate product.

Related: Top tips to take advantage of low mortgage rates

How do I get out of a fixed rate mortgage?

To get out of a fixed rate mortgage, make sure to read through your terms and conditions and be fully aware of any associated charges (if any). After this, it’s as simple as contacting your lender – but be warned, there could be a heap of associated paperwork.

Before going to all the effort of breaking a fixed-rate mortgage, ensure you understand the ins and outs of what you are wanting to change to and be sure it’s worth it.

Why doesn’t Australia have 30-year fixed mortgages?

The main reason that Australians don’t have access to 30-year fixed mortgages is that our secondary mortgage market isn’t developed enough. In America, lenders can offer 30-year loans and know there is a high likelihood they will be able to sell the loans onto investors, meaning they don’t have to have them sitting against their balance sheets. In Australia this isn’t possible.

Besides this, Australians overwhelmingly prefer variable-rate mortgages, so with little interest in the market it is unlikely Australians will see 30-year fixed rate terms anytime soon.

Words by Kathryn Lee

Related: How to get a home loan on maternity or parental leave

Are you looking for your first home? Consider using an eChoice broker. With access to 100s of home loan products from over 25 lenders, eChoice brokers have the resources to find YOU the best deal.

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