Fixed versus variable: what is the difference?

Or split the difference?

Interest rates invariably dominate headlines whichever way the trend might be. In the current low rate environment, many lenders adjust their variable interest rates while also offering competitive fixed rate options. 

So it seems to be as good a time as ever to consider changing your provider or even re-structuring your current loan to make the most of the multiple options out there.

When it comes to choosing a home loan to suit your needs, it’s important to understand that flexibility can be the key to success. And one way to do this could be to split your loan between a fixed and variable rate.

Benefits of a fixed rate

Planning - a fixed interest rate allows you to plan for the future with the knowledge that you will pay the same amount each month for the length of the fixed rate period. 

In terms of career, your lifestyle decisions and savings plan, knowing what you’re going to be forking out can be a big comfort.

Protection - in an uncertain economy, protecting yourself against sudden interest rate rises can be just as important as securing the best rate for your mortgage. 

If you want to know what your repayments will be from month to month, locking in an interest rate may be a wise decision.

Potential pitfalls of a fixed rate

You need to be aware that if you want to make prepayments larger than an amount specified by the home loan provider, you may be required to pay break costs, which can be considerable. 

While fixed rates protect you when rates rise, if you have a fixed rate and rates drop, you don’t get the advantage of that rate movement.

Benefits of a variable rate

While a variable interest rate can seem a little riskier, it is one of the most popular choices for Australian home loans.

Pay down a mortgage more quickly - one benefit of having a variable interest rate is being able to take advantage of more prosperous times in your life to make a dent in your mortgage. 

Sudden windfalls, inheritances or tax returns can be funnelled into the mortgage, allowing you to make greater headway than with a fixed rate mortgage.

Take advantage of low rates - in the current low interest rate environment, it can make a big difference in your household’s monthly budget if all or part of your mortgage rate is variable - especially if you maintain home loan repayments at the same amount before the reduction is introduced.

However, you also need to be prepared if the market changes and interest rates start to increase. It makes good financial sense to plan and budget for potential interest rate rises and try to get ahead on home loan repayments when interest rates are lower.

Split the difference

Another option might be the ‘best of both worlds’ scenario of part fixed and part variable to leverage the advantages of each. 

In splitting, the percentage allocated to a variable interest rate should be based on what you’d comfortably be able to afford should interest rates suddenly rise.

Secondly, consider your plans for the next three to five years. Do you hope to pay off a certain amount of your mortgage in this time?

Thirdly, think about the amount you wish to pay back (in addition to the minimum repayments of your mortgage) and make this amount variable.

And finally, make sure to account for savings plans and lifestyle changes. That is, try not to over-extend when it comes to a variable rate; instead choose to safeguard existing repayments with a fixed rate.  

The information here is of a general nature only and is not intended to constitute financial or tax advice. You should consult your professional adviser, accountant or taxation expert for advice specific to your personal circumstances. 

Credit criteria, fees and charges apply to RAMS home loans.