There has been buzz in the market of late about an increase in people seeking to lock in fixed rate home loans. Everyone with a home loan either has a variable or fixed rate, or a combination of the two. So back basics, what are the differences and why does it matter?
Variable rate home loans have rates which fluctuate over time, generally in line with the RBA (Reserve Bank of Australia) official interest rates. This month, once again, the RBA left this rate untouched at 2.0%. (Although in recent times banks have made changes not in line with the RBA decisions – read more on that here). Variable home loans are the most common type of loan in Australia.
Fixed rate home loans have rates fixed for a specified amount of time (and then generally revert back to the standard variable rate at the the end of the loan period). Sounds simple, but there are quite a number of people that have entered into fixed rates and then been surprised to discover that fixed really does mean fixed and that there are significant break clauses – but more on that later.
So why choose one over the other? What is this – the casino?
Well, sort of. When deciding which to go with variable or fixed, you might be trying to predict the future with your crystal ball and guess whether rates are going to go up or down in the future – and which will make you better off – the variable rate in the future or the rate that is available for you to fix in now.
But there are also some fundamental differences in these types of loans which might or might not suit your circumstances.
Variable rate loans often come with features like offset accounts, or the ability to pay off whatever you would like to on your loan, which means if you have some spare cash to park in your offset account or pay down your loan principle, you can reduce the interest you are paying. Variable rate loans might also come with other options like redraw facilities. So if you are someone that has or might have additional cash on top of your mortgage payment – these features might be of benefit to you.
A variable rate home loan might give you flexibility if you don’t want to be locked in for a fixed term. On the flip side, you then need to have the flexibility to absorb any costs from potential rate rises. That is where the crystal ball can come in.
Here’s a chart which illustrates just how ‘historically low’ interest rates currently are.
Variable rates give you a lot of flexibility, but a degree of uncertainty.
Interest rates have remained stable for some time, but if a whiff of expectation comes along about possible increases (or actual increases), interest (pardon the pun) in fixed interest rates tends to increase.
Fixed rates give you certainty for the period you lock them in for. And for some, certainty helps with budgeting or even just psychologically knowing where you stand. For others, they are locking in fixed rates as a punt on the current fixed rates being lower over the fixed term of the loan than what the variable rate will end up being. There many home loans that were fixed in excess of 5.0% a few years ago as it seemed like interest rates couldn’t possibly go any lower. Unfortunately, of course, this didn’t turn out to be the case. (However it’s easy to have 20/20 vision in hindsight and it could easily have been the other way with variable interest rates rising).
Fixed rate home loans can also contain some fine print. One is that the break costs are often the full cost of the interest you would pay for the life of the loan (ouch!). Another is that fixed loans can contain restrictions on paying additional amounts off the principal of the loan (either it is not allowed, or there is a maximum amount you can repay) and offset facilities may not be allowed. For some, these features rule out wanting to take up a fixed rate.
And if you like the sound of variable and fixed, there is the option to have both and have a split interest home loan with a variable and a fixed component. It is a way to hedge your bets and take on the features of both fixed and variable loans. You get certainty with the fixed amount, but if you want to make additional payments, you can do this on the variable component of the loan. Depending on the type of loan or lender, there may be costs involved with setting up each split of the loan
So – whats the wash up of all this?
- You are at the mercy of market forces over the life of your loan, your rates could go up, they could go down
- You need to be have the flexibility to pay your mortgage should rates go up
- On the flip side, you will make savings if rates go down (which you can put towards extra home loan payments, or that overseas holiday)
- You can generally find options with offset accounts or additional payment options, so if you have spare cash you can park it in your offset account or pay it off the the loan and save money in interest
- You get certainty for a set period of time
- The certainty might assist you to budget, or give you peace of mind
- There are likely to be break costs if you want to end the agreement before the end of the fixed loan term (ie you want to sell your property, refinance or the variable rate is lower and you want to switch to variable)
- There is likely to be restricted features in terms of additional payments, offset accounts or redrawing money
- The best of both worlds! (or jack of all trades, master of none?)
- Although you gain the advantages of both fixed and variable loans, you also get the disadvantages
- Offers the advantage though (over a 100% fixed loan) that you usually have the option to pay down your loan on the variable component.
So fixed, variable or split?
It often comes down to your circumstances and your preferences. Whether you prefer flexibility over certainty, whether you want to take chance on one being more financially beneficial than the other with your prediction of rate changes and whether you want or need certain features like offset accounts and redraw facilities.
If you are thinking of making changes to your loan type, or are coming off a fixed rate term in 2016, be sure to get in touch to talk through your options.
You can contact Doug at (e) firstname.lastname@example.org or (m) 0408 671 524.
Douglas Piening is a Mortgage and Finance Broker with Choice Home Loans and is passionate about providing clients with lending advice they can trust. Whether it’s re-financing an existing property, buying a new or next home, or investing, he brings a wealth of knowledge and expertise to assisting clients with their lending needs.
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This information is of a general nature only and does not constitute professional advice. You should always seek professional advice in relation to your particular circumstances.