Recently we wrote about what will happen to all those people who have a fixed rate loan expiring soon. You can read that article here …
We received quite a few questions about what type of loan is best, so today we will try to summarise and simplify things.
Of course, it is important to understand that the information here is of a general nature, and it does not take into account your financial circumstances, financial goals,
or needs. Before you make any decision it is important that you seek personalized professional advice.
If you are considering a home loan and you’re wondering which type of loan is best for you, fixed rate or variable? Or even a combination of both, it is important to understand what the difference is. And of course, what are the pros and cons of each?
Fixed Rate Loan
A fixed interest rate loan gives you certainty about what your interest rate is.
And therefore what the repayments are, because, as the name suggests, the interest rate is fixed and it is fixed for a set period of time. For many this gives them a great deal of peace of mind. This means that you will know that your repayments will not be affected if the market rate rises or falls. Your repayment amount will be frozen based on the interest rate at the time that you fix the loan and for the period of time that you have agreed to fix the rate for. The fixed-rate period of time could be anywhere between one and 10 years, depending on the lender. But in most cases, the fixed period is between one and five years.
Pros of Fixed-Rate loans
This type of loan is especially helpful for people who are new to the home loan market and are a little bit nervous about their first loan. Homeowners that have a stable but tight budget or perhaps homeowners whose circumstances are going to change for a period of time. Maybe you have a baby on the way and you know you will be reduced to a lower income for a period of time.
Cons of a Fixed Rate loan
The trade-off, though, for this certainty is that you have very little flexibility when it comes to what you can do with your loan during the period that it’s fixed. Most of that flexibility is lost when it comes to making additional payments off your loan to reduce the amount of interest that you pay and access to additional features, like offset accounts.
Although some lenders will allow you to pay small amounts each year off your loan while it is fixed. Those additional amounts will not be available to you to redraw, should you need the money back, until you are out of the fixed period. One of the most important things to remember is that during the fixed rate period, you cannot refinance restructure or payout your loan without incurring a break costs penalty.
That is the trade-off for the repayment certainty that you get.
Variable Interest Rate Loan
If repayments certainty isn’t something that’s important to you. Then it may be best to consider a variable rate loan which will give you much more flexibility than a fixed rate loan does. But you do lose the certainty that you’re repayments will not change. Those repayments will change whenever you’re lender changes their interest rate.
Benefits of a Variable Rate home loan
The benefits that a variable interest rate has over a fixed interest rate is that you can pay additional repayments off your loan, which will reduce the amount of interest that you will ultimately pay to your lender.
A variable rate loan will also allow you to refinance or restructure your loan or even pay out your loan without any penalties.
Many variable home loans have lots of features that will allow you to take control of your finances and put yourself into a better financial position.
A variable-rate mortgage may be the best option for people who know that their income is going to increase and they want to be able to make additional payments when they can. To pay their loan off more quickly, or perhaps people that know they have significant savings that they want to sit in an offset account, but want to still have access to those funds at a later date?
Of course, with the flexibility that you get by having a variable home loan, So does the lender. The trade-off for the lender in not having certainty is that they can increase their interest rate if the market rates are rising. Now if we see lower interest rates then you will be jumping for joy because you’re repayments will also drop with a variable loan.
If the interest rate is fixed, you may not be able to take advantage of this reduction in market interest rate changes. The other side of the coin, though, is if interest rates are rising. So we’re your repayments under a variable rate loan, whereas on a fixed rate the lender cannot pass on the rate increases to you. Those with the fixed rate will be the ones jumping for joy.
Which type of one that is best for you will be determined by what is most important to you this certainty of the fixed rate or the flexibility of the variable, right? Still not sure.
Well, there is one more option available a split right?
Split right is sometimes thought of as the best of both worlds. Part of your loan is fixed rate loan. The remainder is a variable-rate loan. You might split your loan with 50% in fixed 50% invariable or 20% in fixed 80% variable or any other combination you like. The amount in each is up to you and it will be determined by your individual circumstances.
When you structure your loan as a split rate, you will have certainty on part of your loan with repayment amounts and interest rates, and flexibility on the other part of the loan. My advice is to talk to a professional mortgage broker who can work with you to determine the best product, rates, features and options that suit your own personal financial situation.
A mortgage broker is required by law to act in your best interest. If you need more information on anything that I’ve talked about here, please get in touch.