Should you lock in your interest rate for a fixed period? Or take a chance on interest rates dropping even further and choose a variable rate? Unfortunately, there’s no simple answer to these questions. To help you make an informed decision, we’ve outlined the pros and cons of fixed and variable interest home loans.
Variable interest rate loans
A variable interest rate moves with changes to the market interest rates – either up or down – and your loan repayments move accordingly too. If interest rates drop your repayments go down, but if interest rates rise so do your repayments.
A big advantage to variable interest rate loans is the amount of flexibility they offer. Most are structured in such a way to allow you to make extra repayments when you can, which helps you save on interest and could shave years off your loan.
These types of loans may have additional attractive features like unlimited redraws on any additional repayments you’ve made, or the ability to save even further on interest by setting up an offset account. It’s also usually easier and cheaper to switch home loans if you’re not locked into a fixed rate, so if there are better deals out there you’ll be able to take advantage of these.
On the flipside, variable interest rate loans make it harder for you to budget, as loan repayments could change from month to month. And, if you’re already pushed to your limit with your repayments, any increase in rates could cause considerable stress.
Fixed interest rate loans
With a fixed interest rate loan, the interest rate is set for a limited period – between 1 and 5 years – and is not affected by any movements in the market. This means your repayments remain at the same, fixed rate for the length of your loan term before usually reverting to a variable interest rate.
Many home buyers, particularly first home buyers, choose this type of interest rate. It works well for borrowers on a strict budget who need the certainty of paying a fixed amount each month, particularly important in times of economic uncertainty when interest rates could potentially rise.
The disadvantage is of course losing out when interest rates drop as your loan repayments remain fixed. Some lenders charge a fee for making any extra repayments during your fixed rate term and breaking a fixed rate loan could be costly.
Split loan option
Some lenders may offer the option of a split home loan interest rate where part of your loan is on a fixed rate while the remainder is on a variable rate, essentially offering you the best of both worlds!
While you’re covered from interest rate rises with the fixed part of your loan, you enjoy the advantage of any rate drops and you’re able to make additional payments when you can without added fees with the variable part of your loan.
It’s worthwhile talking these options over with your mortgage broker to find out which loan option best fits your unique situation.
Source: Mortgage Express