Fixed vs Variable Rate In 2020? Which Is Better?
Finding the right home loan is as much about you as it is about the product – what are your goals? How much risk are you willing to take on? How tight is your budget? There are many home loans that cater for a wide variety of needs, so you’ll want to keep your requirements in mind as you look around.
Fixed and variable loans are two major options that you’ll need to decide between, with their own advantages and disadvantages. Let’s look at the difference, and which one might be right for you.
What is a fixed or variable rate?
An interest rate is a percentage of the amount borrowed from a lender that is taken as a charge for being approved to borrow that amount.
Interest rates change over time, depending on wider economic factors. Sometimes interest rates increase, and sometimes they fall. Generally, variable interest rates give borrowers the opportunity to be more flexible with their repayments and to take advantage of any drop in interest rates.
A fixed interest rate locks in a particular rate for a period of time, giving stability and predictability for the amount of time the rate is fixed for. Lenders generally offer different options for the length of time the interest rate can be fixed.
Which is better?
The truth is, there’s no single correct answer to which type of loan is better, because no one can predict the future and everyone has different needs. If interest rates drop, then people who have fixed their loans at the higher rate are at a disadvantage. If interest rates rise, however, homeowners on a variable rate end up paying more.
Instead of looking at which is better, it’s more helpful to look at the pros and cons, and weigh them up against your personal goals and circumstances.
Variable rate
Pros:
- Often more flexible with repayments. If you’re committed to repaying more than the minimum off your loan, most likely a variable rate home loan will suit you better. They generally have lower fees if you make changes or exit early as well.
- Access to redraw. Many variable loans offer buyers the chance to access any extra money they’ve paid off their home loan that is over and above the minimum repayment. It’s a handy option for unexpected emergencies.
Cons:
- Increased payments. If interest rates rise, your repayments will increase. That can affect your financial goals.
- Change of circumstance. You might have dreams about repaying early, but as life intrudes you could be left with higher repayments, making it more difficult to budget.
Fixed rate
Pros:
- Predictability. The major counterpoint to the variable rate home loan’s advantage of flexibility is the stability of the fixed rate option. For the period of time the loan is fixed, the
- Protection. Fixing your loan protects you against interest rate rises, as you’ll stay at the agreed rate regardless of what the market is doing.
Cons:
- Miss any interest rate reductions. If you fix your loan and the interest rate drops, you’ll still have to stick with the agreed on amount.
- Reduced flexibility. A fixed rate locks you in to the agreed amount and payment plan. If you try to deviate from that by making too many extra repayments or exiting before the fixed rate is up, you could be faced with heavy fees. You probably won’t be allowed an offset account.
- No changes. If you could want to sell your house, refinance your loan or renovate using equity within the fixed period, you could find your options extremely limited or very expensive while your rate is fixed.
Splitting your loan
If you can’t decide between a fixed or variable interest rate loan, you might be able to have both. Some lenders will give you the option to nominate an amount of your loan that you wish to fix, and to leave the rest variable. That leaves you with the benefits of the fixed rate on some of your loan, with the flexibility of a variable rate loan.
Locking your rate
If you choose to fix part or all of your loan, you might want to consider rate locking your loan. That means locking in the interest rate at the time you apply for the loan. If you don’t, you’re likely to be stuck with the interest rate at the time of settlement. If it’s the same or lower, it won’t matter so much, but if interest rates rise you could be locking in a higher percentage than you thought you were agreeing to.
Choosing your loan type
Choosing the type of loan that suits you is a decision based on a lot of factors – your financial goals, your preference for stability or flexibility, and a little bit of gambling on whether interest rates will increase, decrease or stay the same.
If you have a clear preference, it makes it easier for you to undertake some independent research on home loans that might be available to you. For most people however, it pays to speak to a professional who can guide you and let you in on some loans with special conditions that might apply to your situation.
Whatever you choose, carefully consider:
- Your future goals
- What you might reasonably expect to happen in the next few years
- Whether you can afford to pay more if interest rates rise
- If you want the freedom to make extra repayments
- How much you would like added features like an offset account
A loan is a major commitment, and you’re likely to be working with your lender for many years to come. Regardless, making sure you have all the information, considering carefully what suits your situation the best, and reading the fine print is absolutely vital, no matter which type of home loan product you choose.