Fixed vs Variable Home Loans: Which Is Best for You?

What Are Fixed and Variable Home Loan Rates?

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“When is the best time to fix my home loan or should I stay variable?” This is a common question, and there is no straight forward answer as everyone’s financial position is different. In this article, we will explore the pros and cons of each option to help you decide which is right for you. You may also consider a combination of fixed and variable by splitting your loan into two or more separate loans.

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What Is a Variable Rate Home Loan?

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A variable rate home loan is subject to change. In Australia, this is usually in line with the RBA (Reserve Bank of Australia) cash rate. This means that when the cash rate goes up, so does the interest rate on your mortgage. Conversely, when the cash rate goes down, your interest rate goes down with it.

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If you have a variable interest rate, you should keep an eye on communication from your lender when the RBA announces a rate change, as lenders are not required to pass on the rate cut in full. For example, the RBA may reduce the cash rate by 0.25%, but your lender may only reduce your rate by 0.15%. This is a good time to review your home loan with your lender or broker as there may be other lenders offering more competitive rates.

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It is also important to note your interest rate is subject to move outside of RBA changes, at your lenders discretion.

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Advantages of Variable Rate Loans

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A variable rate product is a great option for borrowers wanting to reduce their loan balance quickly. Most variable rate loans offer unlimited additional repayments, with no penalty for paying off your loan early. If you receive an inheritance or decide to sell your home, you can repay your home loan without additional fees or charges.

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Most lenders offer what’s called a “redraw facility”. A redraw facility allows you to make additional repayments, above your minimum payment, allowing you to “redraw” those additional payments for future use. This means borrowers can reduce their interest payable as the balance of their loan is decreased for the duration that those additional repayments are held in their home loan.

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Some lenders also offer an offset account, usually at additional cost, which works similarly to a redraw facility, but has some differences, including tax benefits. An offset account helps you reduce the interest payable on your home loan while keeping funds accessible in a bank account. The interest on your loan is reduced by the funds held in your offset account. Most lenders will provide you with a debit card attached to your offset account, which works great for people who have their salary paid into their offset account, allowing them to access funds for daily expenses, whilst minimising interest on their loan.

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To give an example of how an offset account works, let’s say you have a home loan of $500,000, but you have $100,000 in your offset account. Your lender will charge interest on your loan based on a loan of $400,000.

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If you want to read more about offset and redraw facilities, check out our other article on this topic.

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One of the advantages of using an offset vs redraw is if you have an investment loan that you are claiming tax deductions on and decide to use extra funds to reduce your loan, you can still access these funds if needed for personal expenses, such as buying a car. However, if you withdraw the funds directly from your loan, the ATO considers it a separate loan, which may no longer be tax deductable. An offset account avoids this scenario by keeping funds separate. It’s best to consult a tax accountant for advice specific to your situation.

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Disadvantages of Variable Rate Loans

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Variable rate loans are unpredictable – if interest rates rise, so will your repayments, which can make it difficult to budget. Additionally, lenders can have the discretion to change rates at any time, not just in response to RBA announcements.

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What is a Fixed Rate Home Loan?

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A fixed rate home loan is a home loan that has a rate that does not change for the duration of the fixed period. Most lenders offer fixed rates for 1, 2, 3, 4, or 5 years, and even longer with some lenders, at an agreed interest rate. This means that as interest rates change, whether up or down, your interest rate on your home loan remains the same, and therefore your repayments will remain the same during the fixed period.

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Benefits of Fixed Rate Home Loans

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A fixed rate loan is ideal for borrowers who want to know exactly what their repayments will be. It’s great for those on a strict budget orthose concerned about rising interest rates. When rates rise, you won’t see any increase until your fixed period expires, but it also means that your rate will remain the same when interest rates decrease.

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At the end of the agreed period, usually 1 to 5 years, you will revert to a variable rate, and this is subject to whatever the lender is offering at the time your fixed rate expires.

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Considerations When Choosing a Fixed Rate Loan

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The downside to fixed rate loans is that you miss out on rate reductions if interest rates fall. Most fixed rate loans also lack features like offset accounts or redraw facilities. While some lenders allow up to $10,000 per year in additional repayments on your fixed rate without penalty, you typically cannot access these extra funds until the loan reverts to a variable rate. If you want to pay off your loan early, sell your home, or otherwise break the fixed rate agreement, you could face significant penalties. This will depend on several factors such as how long you have left on your fixed term, and interest rate trends. It’s crucial to discuss this with your broker and lender before you consider selling your home or breaking your fixed rate.

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Splitting your Home Loan: The Best of Both Worlds?

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If you’re still unsure whether a fixed or variable interest rate is right for you, most lenders will allow you to split your home loan into two or more loans. This will allow you to benefit from both rate types: the security of a fixed rate, and the flexibility of a variable rate. This works great for people who want to lock in an interest rate for a portion of the debt, while still being able to make additional repayments on their home loan and take advantage of an offset account should they wish to.

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Speak to an Expert About Your Mortgage Options

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If you want to discuss your home loan and get tailored advice, arrange a 1 on 1 appointment with one of our experts today.

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