Understanding fixed, variable and split rate home loans

Should you fix your interest rate, opt for a variable one, or do both? We explain the benefits and considerations of all three options.

Of all the decisions that need to be made when choosing a home loan, finding the best interest rate is one of the most important. After all, a rate that’s even 0.5% lower could save you thousands of dollars over the life of your loan.

On top of that, it’s important to consider the type of interest rate that best suits your circumstances – fixed, variable, or split, which combines elements of both. Below we explain the pros and cons of each.

What is a fixed-rate home loan?

A fixed-rate home loan has a defined, unchanging interest rate during the fixed-rate term.

Interest rates can be locked in for a period of time, generally one to five years, and will depend on things such as the total amount borrowed and the loan term.

At the end of the fixed-rate term, you can then choose to fix your rate again, or move to a variable interest rate.

Advantages of a fixed-rate home loan

One major benefit is that the home loan interest rate won’t fluctuate during the fixed-rate term.

This has two advantages – one, it may help you to budget more accurately (as your loan won’t be susceptible to changes) and two, it could help you avoid potentially higher monthly repayments should interest rates rise unexpectedly during the fixed-rate term.

Other considerations with a fixed-rate home loan

There are things to take into account if you’re thinking about a fixed-interest rate. For instance, while you won’t be subject to an interest rate rise, a reduction in interest rates also won’t be applied to your loan.

A fixed-rate loan also doesn’t typically give you the flexibility to make additional repayments above the required amount, should you wish to pay off your loan faster.

In saying that, there are some fixed-rate home loans that do allow this, but only to a specified amount. For example, you may be able to contribute up to $10,000 in extra repayments per year on some fixed-rate home loans.

Additionally, any changes to a fixed-rate loan, such as exiting it before the loan ends, could attract break costs, which may be substantial, so make sure you read the fine print.

What is a variable-rate home loan?

A home loan with a variable rate may see the interest rate you pay over the life of your loan change, as the interest rate could go up or down, depending on a number of circumstances.

When determining the current interest rate on a variable-rate loan, banks will consider a number of factors, including the RBA cash rate, the cost of various forms of funding available to the bank, such as retail deposits and wholesale funding, and other market conditions.

Advantages of variable-rate home loans

If your home loan provider drops its interest rates, you’ll benefit from lower interest charges.

A variable-rate home loan also allows you to make additional repayments on your home loan at any time without penalty and if you do take advantage of interest rate reductions, you could put what you save into your loan, which may allow you to pay off your loan sooner.

Generally, you’ll have access to any additional repayments you’ve made on top of your minimum repayments via a redraw facility as well, which most variable-rate home loans offer.

Many variable-rate home loans also offer access to one or more offset accounts, which you can link to your variable-rate home loan.

This could provide cost benefits, as money in an offset account will be subtracted from your home loan when interest is calculated. This reduces the interest payable, as well as the term of your loan.

Other considerations for variable-rate home loans

As interest rates are subject to change, increases in interest rates may also apply to your variable-rate home loan, meaning your minimum monthly repayments may go up.

As such, a variable home loan might be more difficult to budget for, as it can be hard to predict whether interest rates will go up or down over the life of your loan.

What is a split-rate home loan?

If you want to take advantage of the features offered on both variable-rate and fixed-rate home loans, you could consider splitting your rate, where a fixed interest rate applies to part of your loan and a variable rate to the other part.

What are the advantages of a split rate?

A split-rate loan allows you to have rate and repayment certainty on one portion of your borrowing, while potentially taking advantage of any interest rate reductions on the other portion.

You also get to decide how much of your loan you want to take as a fixed rate and how much you take as a variable rate. For example, you might fix 70% and have the remaining 30% as variable.

What are the considerations with a split rate?

There could be additional fees payable for managing both accounts, so be sure to check the terms and conditions with your lender.

If you need help with saving for a home loan deposit, contact us today.

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