19 Sep 2019

Should you fix the rate or stick to a variable rate?

Australians have been enjoying low interest rates for some time now, but it begs the question, what will interest rates do next? If you’re one of many Australians taking advantage of record low interest rates with a standard variable rate loan, you may be wondering how long it’s going to last – is it time to switch to a fixed interest rate before interest rates take a sudden hike?

There is much speculation about interest rates, but the reality is, no one can know for sure what they will do next. The decision to fix your rate or stick to a standard variable rate should not be based on interest rate predictions, rather your personal circumstances and financial goals.

What is a variable rate?

Financial institutions provide different types of home loans to their customers. Differences in home loan products will often surround the features offered, loan amount, repayments, security required and of course how interest is charged. There are two main ways that a lender will charge interest. They will use either variable interest rates or fixed interest rates. These different types of interest rates each come with their own advantages and disadvantages. Let’s take a look at what each term means.

Each month the Reserve Bank of Australia (RBA) sets the official cash rate and financial institutions base their interest rates on this figure. If you have a variable rate home loan it means your interest will be largely determined by changes in the official cash rate. This means if the official cash rate decreases, your interest rate will usually decrease. In the same way, if the official cash rate increases so too will your interest rate.

A fixed interest rate refers to an interest rate figure that a lender allows customers to lock in for a set period, usually between 1 and 5 years. This is known as the fixed rate period. When a fixed interest rate is offered it is still influenced by the official cash rate, but if the official cash rate rises or falls during the fixed rate period the interest rate remains the same.

A split home loan allows customers to enjoy both a variable interest rate and a fixed interest rate. A customer can choose to have a portion of their home loan on a variable interest rate and a portion of their home loan on a fixed interest rate. Most financial institutions will allow a customer to choose how they would like to split their home loan, whether it’s a 50/50 split or 80/20 split, it’s up to the customer.

Do fixed mortgage rates change?

Fixed mortgage rates are fixed. This means they do not change during the fixed rate period which could be anywhere from 1-5 years. The appeal of a fixed interest rate home loan lies in its unchanging interest rate which provides predictability to borrowers and allows them to plan ahead. Borrowers are protected from any sudden interest rate rises and their monthly repayments remain the same throughout the fixed period.

So, what happens at the end of the fixed interest rate period? This is when fixed mortgage rates change. At the end of the fixed rate period the interest rate will normally revert to the lender’s standard variable rate. At this point, a borrower can choose to stick with the standard variable rate, refinance to get a better deal or fix their interest rate again.

What is an easy way to calculate my fixed rate?

A financial institution will offer fixed rate interest rates based on their market expectations. If they forecast a drop in interest rates they may offer a fixed interest rate at a slightly lower rate to lock customers in before interest rates drop.

As a general rule, when the official cash rate is low, fixed rates offered by financial institutions are often slightly higher than their variable rates in anticipation of interest rate rises. However, Australia is experiencing a season of consistently low interest rates. The RBA has not changed the official cash rate at any of its last 28 meetings. This has led to some financial institutions offering very low fixed interest rates to customers.

A lender will also take into account your ‘risk’ when deciding what fixed interest rate they will offer you. This means they will consider your loan to value ratio (LVR), income, credit history and personal details. If you represent a lower risk you may be eligible for a more competitive fixed interest rate, while applicants who represent a higher risk to the lender may not qualify for a low fixed interest rate.

A fixed interest rate will also vary according to the fixed term. A longer fixed term will result in a higher fixed rate while a lower fixed rate can be secured with a shorter term.

The above information is a lot to consider, but luckily you don’t have to work it all out for yourself. There is an easy way to calculate your fixed rate using a mortgage rate calculator. Mortgage House offers a ‘Best Rate Mortgage Calculator’ for free. Simply estimate the value of the property you wish to buy, specify the amount you would like to borrow and advise whether you have documentation. Choose a fixed rate and the calculator will provide you with the fixed rates and terms that you are eligible for.

Which rate is right for me?

When it comes to the question of which rate is right for you, the question really should be, which home loan is right for you. Variable and fixed interest rate home loans differ in more ways than their interest rates.

A variable rate home loan gives borrowers more freedom and flexibility. Often a variable rate home loan will allow borrowers to make extra repayments and there may be no penalty if you pay off your home loan early. If you receive an inheritance or a bonus from work, you may be able to use these funds to make extra repayments and pay off your home loan early.

Freedom and flexibility are also helpful when it comes to changing circumstances. For example, if you need to move house, a variable rate home loan may allow you to take your home loan with you, saving you from exit fees and start-up fees if you had to change home loans.

At a time when interest rates are at an all-time low, those with a variable rate home loan are reaping the full benefits. However, even a small interest rate rise can affect a tight budget and those with variable interest rates are at the mercy of an unpredictable cash rate. For this reason, a fixed rate home loan is appealing.

A fixed interest rate home loan is chosen for its certainty and stability. Those on a tight budget can calculate exactly how much their monthly repayments will be over the fixed rate period which means they can plan their budget accordingly. Those on a fixed interest rate are protected from interest rate rises and increased monthly repayments. Unfortunately, this means that if the official cash rate decreases those on a fixed rate home loan can miss out on a lower interest rate and subsequent savings.

In the same way that the interest rate is fixed, the terms of a fixed rate home loan are also rigid and do not allow for flexibility or changing circumstances. Usually, a borrower cannot make extra repayments, or their extra repayments are limited to a certain amount each year. Penalties will apply if you want to pay off your loan early or refinance during the fixed period.

If your future is predictable for the fixed period, for example, you have stable employment, you plan on staying in the same house and your family situation is unlikely to change, then a fixed rate home loan may be suitable. If your near future is unpredictable then you may be locked into a home loan that does not suit your needs, or if you need to change home loans, then you risk paying expensive exit fees.

When deciding which rate is right for you, consider the rate and home loans as a whole and ask yourself the following questions:

  • Will a sudden increase in interest rates affect my ability to meet monthly repayments?
  • Do I have the capacity or means to make extra repayments?
  • What are my monthly repayments likely to be over a fixed period?
  • What are my principal and interest repayments?
  • Will I move house in the next 1-5 years?
  • Is my employment likely to change in the next 1-5 years?
  • What is my family situation and is it likely to change over the next 1-5 years?

Once you have decided on a variable interest rate or fixed interest rate you can look to the comparison rates of individual home loan products. Comparison rates combine the variable interest rate or fixed interest rate with fees and charges to give you the true cost of a loan. You can also look to comparison websites who often rate home loan products – the rating shown on a home loan product can represent what is the best value and provides the best features.

You should always read the product disclosure statement of a home loan product, so you understand the terms and conditions. Sometimes financial institutions will offer introductory rates which revert to a very expensive rate when the introductory period is over.

Does an offset account impact my home loan rates?

An offset account is a home loan feature that helps to reduce the interest payable on your home loan. Offset accounts work just like everyday transaction accounts, however, funds in offset accounts work to ‘offset’ the interest payable on a home loan.

In other words, borrowers will only pay interest on a principal loan amount minus the amount in their offset account. For example, if you have a $500,000 loan amount and $200,000 in an offset account you will only pay interest on $300,000.

Offset accounts are a smart way for borrowers to reduce their interest and maintain access to funds when they need it. Depositing wages directly into an offset account allows for all income to help reduce interest on the principal loan amount.

Offset accounts do not affect home loan rates, rather the interest payable. If your home loan rate is 3.9% then you will still be charged interest based on this rate regardless of what is in your offset account. Using the above example, it will just mean the difference between 3.9% on $500,000 vs. 3.9% on $300,000.

Offset accounts are less common with fixed interest home loans, so if you think you will benefit from an offset account then you may need to consider a variable rate home loan instead.

How can I monitor mortgage rate changes?

Choosing between variable interest rates and fixed interest rates is always a gamble. Interest rates can go up and they can go down. According to Canstar, borrowers have a 50/50 chance of making the right decision when it comes to repayments.

The media reports on RBA decisions to cut the official cash rate or increase it. Keeping an eye on what the media is saying and checking in with your lender is the best way to monitor mortgage rate changes. You should always consider potential rate changes in line with your own goals and circumstances.

Arrange a meeting with a Mortgage House Lending officer to discuss mortgage rate changes and how they could affect you and your situation. Finding the right home loan at the right time could save you thousands!

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