It’s the question a lot of Australians with a mortgage have to grapple with – should I choose a fixed, variable or split home loan?
It’s the question a lot of Australians with a mortgage have to grapple with – should I choose a fixed, variable or split home loan?
A fixed rate loan is a loan with an interest rate that stays the same over a set period of time. Homeowners with a fixed rate loan often find it easier to organise their budget than those with variable loans, as each month they pay the same amount in mortgage repayments.
“Although most lenders allow some degree of additional repayments, your fixed rate loan is a bit like a big ice cube which reduces at a steady, predictable pace,” says John Tindall, principal of a Sydney-based financial advisory firm. “And that means you can budget for it.”
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The main advantage of securing a fixed rate home loan is that you know exactly what your repayments will be over a given period. But there are other advantages, too.
The certainty afforded by a fixed rate loan is a double-edged sword. While it makes budgeting easier, it could also cost you money. Here are some disadvantages of a fixed rate home loan.
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A variable rate loan is a loan with an interest rate that changes throughout the term of the loan, often in response to changes to the official cash rate or variations in banks’ funding costs.
“They have been great for the last 30 years, as interest rates have been mostly declining since early 1989. But they can have a nasty bite when they’re going up,” says Tindall.
Essentially the direct opposite of a fixed rate loan, a variable rate loan offers greater flexibility and a broader range of added features.
As with the fixed rate loan, whether you view a variable rate loan’s features as an advantage or disadvantage will largely depend on your personal financial situation and the state of the market.
A fixed rate home loan is a home loan with an interest rate which remains unchanged for the duration of the fixed term – commonly between one to five years – whereas a variable rate home loan is a home loan with an interest rate that can rise or fall.
Tindall says most people have a variable rate loan, either because they haven’t remortgaged for years, or because they thought that interest rates would drop over time.
“And they’ve been mostly right for the past 30 years,” he says.
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A split home loan is a home loan that allows the borrower to nominate a proportion of their loan as fixed and a proportion as variable. Playing both sides of the fence like this allows borrowers to more accurately manage their home loan’s level of risk and security.
For example, split loans with a larger fixed component afford borrowers more stability than a 100% variable rate loan, whilst still allowing them to make additional repayments so that they can pay off their loan sooner.
And split loans with a larger variable component afford borrowers more flexibility than a 100% fixed rate loan, whilst minimising their exposure to sudden interest rate fluctuations, so that they can budget more accurately.
“In my opinion, it’s mainly a considered choice between predictability and flexibility,” says Tindall.
Sarah and Peter borrow $440,000 to buy a $600,000 apartment.
If they opt for a fixed rate home loan with an interest rate of 1.99% and a two-year term, they will pay $1,634 a month (including $10 monthly fees and based on a 30-year loan period).
If they choose a variable rate loan at 3.5%, they will initially pay $1,976 a month, although their repayments will rise to $2,101 a month if the bank raises rates to 4%.
Given Sarah and Peter plan to have a baby soon, they decide to fix 70% of their home loan for 2 years to reduce their exposure to potential interest rate hikes and make it easier to stick to their budget.
Choosing a split loan rather than a fixed rate loan also allows them to make extra repayments when they can afford to do so.
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As with most financial matters, neither option is better than the other; which option is best for you depends on your personal situation and the state of the market.
“If you’re concerned about the impact on your family budget, then consider a fixed rate loan,” says Tindall.
“If you want to smash your loan down, consider a variable rate. If you want a bit of both, then split. And if you’re confused, ask your Home Loan Specialist.”
Originally published on realestate.com.au as ‘Should you choose a fixed, variable or split loan?