YBR

What's the difference between a fixed and a variable home loan?

In this article:

Fixed rates are locked in for between 1 and 5 years Variable rates change with the Reserve Bank’s official cash rate Fixed rate gives you certainty, while variable is usually flexible

First home buyers, as part of the loan application process, are asked ‘fixed or variable rate?’ The choice is simply this: will your mortgage interest rate shift slightly as the Reserve Bank adjusts its official cash rate? Or will you pay a fixed interest rate for a defined period, usually two, three or five years?

No one can give you a definitive answer on the question of fixed versus variable: it’s one you have to decide for yourself. People typically take fixed rate loans for two reasons: they are property investors and they want to be certain of their interest costs over a defined period so they can write a budget; or, they’re a household and have taken the view that rates are at a low point in the interest rate cycle and likely to rise in future.

Some households on a tight budget may also be tempted to fix their rate to reduce the risk on stretching their budget with a variable rate rise. The benefit of a variable rate loan is that whether the rate is rising or falling or flat, you are paying the market price for housing debt, in that particular time frame. Most owner-occupied mortgages in Australia are variable rate loans, making us unusual by world comparison. One reason for this is that people who take a variable rate loan might assume that they can find extra funds if the rates rise.

However, before making this assumption, prospective borrowers should use an online mortgage calculator and see what extra mortgage repayments they’ll be responsible for if their variable rate rises 1.5 or 2 per cent in a year. Most home loans have been ‘stress tested’ by the lender to ensure there is enough household income to cover a rate rise, but you should also understand the impact of an interest rate rise yourself. Fixed rates have the attraction of certainty, but if you fix your rate at 5.5 per cent, and then the variable rate drops to 4.8 per cent, you are now paying more than the market rate, for as long as your loan term. Also, fixed rate loans often don’t allow accelerated pay-down strategies such as extra repayments and lump sums. Fixed rate loans also have a ‘break fee’ to leave the loan early.

For people who don’t see a clear case for either type of loan, consider this: if a lender offers a 3-year fixed rate loan at the same interest rate as their variable rate loan, then the lender is assuming the variable rate will be going down. If in doubt, remember that most lenders will allow you to ‘split’ your loan between fixed and variable. This gives you the certainty of one and the market-best rate of the other. Very few people accurately predict where interest rates will be in two or three years. In the end you must go with the loan that suits your circumstances.

Home loan hints and tips

 
Being prepared when getting your home loan 
Applying for a home loan is the first step towards home ownership. It’s an exciting time, but it’s also a complex process, which includes several basic steps.
 
Can I get a mortgage if I'm not in the mainstream of borrowers? 
The most straightforward home loan applications are those from borrowers who have saved 20 per cent deposit and who worked fulltime for at least a year, under a PAYG salary arrangement. These are straightforward because the lender can see that the borrower has saved the deposit from their own income, and that they have regular employment at a certain salary. If they also have a good credit history, their application moves quickly.
 
Can I use equity in my property to build wealth? 
Some first home buyers want to turn their property into more wealth, which they do by growing their equity: that is, the part of the property’s value that is not owed to their lender. There are two kinds of equity to think about.
 
How can a mortgage broker help me get a home loan? 
Finding the right home loan can be a complex and time-consuming task, especially for first home buyers. Many borrowers navigate the daunting number of options by using a mortgage broker to source their loans – around half of residential mortgages are now written by brokers in Australia. But is a broker for you?
 
How can an offset account help me repay my home loan faster? 
If you can reduce the interest payments in your home loan, you speed the repayment of the principal amount and accelerate the pay-out of the mortgage.
 
View all articles