Choosing between a fixed rate or variable rate home loan
There are many options available to you when taking out a home loan these days. One of the first decisions you will need to make is whether to choose a fixed rate home loan or a variable rate home loan. Here we look at each interest rate option including the advantages and disadvantages of each.
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Difference between a fixed rate and variable rate home loan
The difference between a fixed rate home loan and a variable rate home loan is quite simple really. A fixed rate home loan has a set interest rate for a specified period of usually between one and five years. On the other hand, a variable interest rate can rise or fall at any time depending on changes to official interest rates set by the Reserve Bank of Australia (RBA).
Advantages and disadvantages of a fixed rate loan
The main advantage of a fixed rate home loan is that you can lock in your interest rate, and therefore your repayments, for a specified period. You can usually choose between a one and five year fixed interest rate, however fixed rates of up to 10 years may be available from some lenders. By locking in your interest rate, you will have certainty in your mortgage repayments. They will remain the same for the entire term of the fixed rate. When interest rates are rising, the benefit of a fixed rate option is obvious. You will still be paying interest at the lower rate and your monthly repayments will not increase.
However, if official interest rates fall, then you will be stuck with your repayments calculated using the higher interest rate.
Another disadvantage with fixed rate loans is that generally you will not be able to make extra repayments off the fixed rate amount, or you may not be able to pay out the loan early. Some lenders now however may allow you to pay a certain amount extra off your fixed rate loan.
Visit our home loan resources page for more on fixed rate loans.
Advantages and disadvantages of a variable rate home loan
Variable interest rate loans offer far more flexibility than fixed rate loans. You can usually pay extra off your mortgage at any time in order to reduce the overall amount of interest you will pay over the life of the loan. Variable rate loans offer many features such as redraw facilities and lines of credit.
If interest rates fall, unlike the fixed rate loan, your monthly mortgage repayments will actually decrease. If, however interest rates rise, your mortgage repayments will increase. This results in less certainty with variable rate loans.
Visit our home loan resources page for more on variable rate loans.
What should you decide?
You will need to consider the pros and cons of the fixed rate and variable rate loan. If you want a flexible loan that will allow you to make extra repayments, then you may need to consider the variable rate loan. If you want certainty in your repayments, then perhaps consider a fixed rate loan. If you want the best of both worlds, you may want to consider a split loan which allows you to have part of the loan at a fixed rate and part at a standard variable rate.