Erin Delahunty - 20 Jul, 2021
Economic stimulus to help Australians recover from the Covid-19 downturn has seen fixed interest rates at their lowest level in recent history.
But how long will it last? Should those with a mortgage lock in the low rates? Or stick with variable? Or look at a mixture of both? Here’s everything you need to know about fixed versus variable rates.
Fixed interest rates give you a guaranteed interest rate for a set period, normally between one and three years, although some lenders offer four and five-year fixed terms and sometimes, but not often, 10 or 15-year terms.
A fixed rate gives you peace of mind, allowing you to plan your finances, safe in the knowledge your repayments won’t increase for any of the myriad factors that drive lenders to bump them up.
The downside is if interest rates fall, you’re locked into paying the higher fixed rate for the remainder of the fixed-rate term.
If you decide to cancel your contract for any reason, such as selling your property, you may have to pay hefty fees reflecting your lender’s lost income. For those wanting to switch from fixed to variable, costs can eat into any savings.
Lenders generally don’t allow fixed rate customers redraw or off-set facilities and can limit or even refuse additional principal repayments. Most Australians on fixed rate loans fix them for one to two years.
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Variable interest rates rise and fall, loosely based on the strength of the Australian economy.
In technical terms, they are mostly tied to the official “cash rate”, which is currently sitting at a mere 0.1% and isn’t expected to rise significantly until 2024.
There are however other factors at play, including costs incurred by lenders, obligations to shareholders and global economic drivers.
Consequently, variable interest rates can rise or fall quickly in volatile times or stay relatively static when the economy is stable.
To attract more borrowers to variable rate loans, which can earn lenders more money over time, variable interest rates have traditionally been set lower than for fixed rate loans, although that’s not the case at the moment.
Lenders also offer other carrots, such as the chance to reduce your overall interest charged through offset accounts or additional principal repayments, as well as the flexibility to redraw any additional capital you have in your mortgage.
Most Australians paying off their home have a variable rate mortgage.
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There are a few things to consider when deciding which loan to choose.
Interest rate, per annum: The interest rate, also known as the “advertised rate”, is the most obvious way to compare. Be aware though, it’s typically low to attract your eye. Shop around online or use a comparison site to get a good picture of what each lender has on offer.
Comparison rate, per annum: Look out for the difference between the interest rate and the comparison rate. If there’s a notable difference, it’s likely the loan has hidden charges that may mean the lower interest rate is not as good a deal as it seems.
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Monthly repayment: This is the minimum repayment each month. Is it within your budget? For variable rates, this can go up and down, so give yourself a buffer.
Application fee: Also known as an establishment, upfront or set-up fee, 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.
Loan term: This is how long the loan will last overall.
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 them?
The comparison rate is a better indication of the actual cost of your loan, calculated on the advertised rate, plus any fees and charges.
At the moment, possibly yes. But that can change. Rates, whether fixed or variable, depend on a range of factors, with lenders balancing the cost of providing the loan versus the need to be competitive.
When the cash rate is falling, banks seek to get more lenders into fixed rate mortgages to secure their repayment amounts before the market drops any further and consequently price these loans lower.
On the other hand, when the cash rate is rising, lenders push their variable rate options through lower interest rates, to entice borrowers away from the “safer” bet of a fixed loan.
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Depending on your circumstances, it’s potentially easy to switch between a variable and fixed interest rate and vice versa when you stay with the same lender.
However, you’ll need to scrutinise the terms and conditions of your loan, which set out any penalties (fees and charges) that come with a switch.
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Yes, you can have a home loan that has both fixed and variable rate parts, taking advantage of the benefits of both loan types. You can also set the proportion of the loan that attracts each interest type, for instance 50/50 or 35/65.
However, the opposite also applies. If variable rates go up, your repayments will as well.
A split loan also gives you the flexibility of a variable rate loan, such as making additional repayments to reduce the interest on the variable portion of the loan, access to your redraw and the benefits of an offset account.
Setting up a split loan often attracts additional fees and charges, and, of course, penalties if you later decide to exit your fixed-loan commitment.
If you have a fixed home loan, and therefore a guaranteed interest rate, a rate rise won’t impact you during the life of the fixed loan term.
What happens when your fixed rate period ends depends on the terms and conditions of the loan. If you don’t take any action, it’s likely your mortgage will default to whatever the variable rate is at the time. However, you can approach your lender to re-fix the loan at the relevant new rate.
For variable loans, your repayment will increase relevant to the rate increase. For principal and interest loans, this means a greater portion of your loan repayment will be taken up in interest charged, rather than paying down your principal.
Variable mortgage rates can technically change at any time. Generally though, rises and falls are in line with changes to the cash rate, which are announced by the Reserve Bank each month.
Lenders, however, don’t always pass on interest rate changes – either up or down – or may not pass on the full amount.
If the market is stable, rates don’t change that often, however, in volatile markets monthly changes are quite common.
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Principal is the amount of money you borrowed or have left to pay, while interest is the amount the lender charges you, based as a percentage of your principal.
With a principal and interest loan, your repayments cover both the interest accrued and a portion of the principal. So, each repayment reduces the amount of money you owe and consequently reduces the amount of interest you’ll pay over the life of the loan.
Under an interest only loan, your repayment only covers the interest. There is no payment against the principal.
Driven by government policy to reduce the cost of borrowing and therefore inject more money into the economy during the pandemic, fixed rate mortgages have become a lot more common of late.
Some industry experts say the fixed rate market is now 40% to 50% of all home loan lending, compared to 15% to 20% pre-Covid.
Breaking a fixed-rate mortgage contract is as simple as contacting your lender. However, the associated paperwork may not be as straightforward.
Before going to your lender, check through the terms and conditions to understand the costs of breaking your mortgage and weigh up if this is better in the long run than the alternative option.
The main reason 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.
Words by Erin Delahunty
Are you on the lookout to save more on your home loan? Contact eChoice to help you work out your home loan options. With access to 100’s of mortgage products from over 25 lenders, eChoice has the tools to get YOU the right home loan deal.