Interest rates have always been a hot topic for homeowners and homebuyers. The Reserve Bank of Australia recently increased its official cash rate, causing a ripple in the home loan interest rate spectrum and leading many to re-evaluate their home loan rate. When considering fixed vs. variable home loans or evaluating the difference between fixed and variable rate home loans, it is essential to understand the pros and cons of each of them. This will help you make an informed decision on your retirement planning strategy as it relates to housing. Here’s how to navigate the rate or variable conundrum, choose the best option for you, and avoid costly mistakes with your finances.
Table of Contents
- What is a Fixed Rate Home Loan?
- Pros of a Fixed-Term Home Loan
- Cons of a Fixed-Term Home Loan
- Short vs. Long Term Fixed Loan
- What is a Rate Lock Fee for a Fixed Home Loan
- How to Apply for a Fixed-Rate Home Loan
- What is a Variable Rate Home Loan?
- Pros of a Variable Rate Home Loan
- Cons of a Variable Home Loan
- How to Find and Negotiate the Best Variable Home Loan
- How High Will Variable Rates Rise in 2023?
- When Will Variable Interest Rates Fall Again?
- What is a Split Home Loan?
- Fixed Vs Variable Rate Home Loans: Which One is the Best?
- Contact Zanda Wealth Mortgage Brokers to Find the Best Home Loan for You
What is a Fixed Rate Home Loan?
A fixed-rate home loan provides borrowers with the certainty of a fixed interest rate for a set period, often referred to as the fixed rate period. Usually, it is between 1-5 years; however, some lenders may allow up to 10 years to lock your interest rates. This type of loan shields you from potential rate rises but can also keep you from benefiting if rates fall.
Fixed-rate home loans depend on the situation in the market. If the rate is on the rise, the fixed rate will be higher than the variable, and the other way around, if the market is expected to crash.
Banks offer attractive deals for the first few years of a fixed loan to attract new customers. A fixed-rate home loan may be advantageous for first-time home buyers. Still, it is imperative to fully understand the terms and conditions of the loan and its pros and cons.
Pros of a Fixed-Term Home Loan
The pros and cons of fixed loans often pivot around stability. Fixed home loans, particularly the fixed rate home loans, have been less popular than variable rate home loans in recent years, but they do have advantages:
- Provides certainty and peace of mind for borrowers for the duration of the loan.
- The rate doesn’t change even when the official rate rises.
- Allows more precise budgeting and future planning.
- You can choose the duration of the fixed term based on the market situation.
Cons of a Fixed-Term Home Loan
It is necessary to understand that a home loan with a fixed rate doesn’t offer you much flexibility, which comes with disadvantages. Let’s look at the cons of a fixed-term loan that might influence your decision when choosing a home loan.
- You cannot adjust the rate if the official rates fall.
- Less flexibility and payments capped at a certain amount per year.
- Penalties or readjustments of early payout of the loan.
- Exit fees if you decide to shorten the fixed-term period.
- Additional payments are not allowed or limited.
Short vs. Long Term Fixed Loan
The loan term is the period during which you must repay the loan. Shorter-term loans usually require higher repayments but lower interest rates. In comparison, long-term home loans offer lower repayments and higher interest rates.
The general guideline is to go with the lowest interest rates possible because it can save you thousands of dollars over time. However, your financial situation might not allow you to go for higher repayments. In that case, it is wise to choose a long-term loan and gradually pay it over time without putting yourself under financial stress.
What is a Rate Lock Fee for a Fixed Home Loan
You may find a low-interest rate when you apply for a fixed-term loan. However, you may not get the same rate once you finalise the property. The fixed interest rate is usually offered on the day of the settlement, not on a day of a loan application.
Depending on the lender, you may secure your loan by paying a certain rate lock fee (usually up to 0.20% of the loan amount). Some lenders offer it for free for a short time, so you must check with them in advance to find the best option for you.
How to Apply for a Fixed-Rate Home Loan
If you are considering a fixed-interest rate mortgage, there are several things you need to do. You need to understand the market situation and your own finances to find a suitable option. Here are the steps to follow when applying for a fixed-rate home loan.
- Do thorough research about the property market and trends for the next few years.
- Understand your finances and decide which terms and rates suit you best.
- Compare banks and lenders that offer suitable loans and check your eligibility.
- Once you have finalised everything, apply for the loan.
Following those steps might seem overwhelming, and many people don’t have the time and resources to do it. At Zanda Wealth Mortgage Brokers, we can provide expert advice and find the best fixed-term loan that will fit your needs.
What is a Variable Rate Home Loan?
A variable rate home loan or variable interest rate home loan is dependent on the Reserve Bank of Australia’s “cash rate”. Such a type of home loan can be attractive when the cash rate is low, but remember, the rate may rise, leading to higher interest rate rises on your loan.
Variable home loans usually offer more flexibility and are more popular among homebuyers and homeowners. We have looked into the pros and cons of variable interest rates, and here is what you need to consider.
Pros of a Variable Rate Home Loan
Getting a variable home loan comes with certain benefits over a fixed-term one. Most Australians opt for it not only because of its flexibility but also because they can save significant amounts over time. Here are the pros of a variable-rate home loan that may convince you to choose this option.
- Flexibility to make additional payments, increase the size of your loan, make redraws if you need extra funds or finish paying it before the term.
- Possibility to switch loans if you find a better deal.
- Your interest rate can go down depending on the situation in the market.
Cons of a Variable Home Loan
The unpredictable nature of the variable loan is its major drawback. The interest rates go up and down, and while you might benefit if rates fall, you might also face higher payments if they rise. We have analysed the negative side of a variable home loan, and here is a key takeaway.
- You will have to pay more if the rates go up.
- Uncertainty due to depending on the world economy.
- Possible high fees due to extra features.
How to Find and Negotiate the Best Variable Home Loan
Looking for the best home loan is not an easy task, and it will require some effort if you want to make sure you spend your money wisely and won’t put yourself under financial strain. Below are the key points to look at when applying for a variable home loan if you want to get the best deal possible.
Loan-to-Value Ratio (LVR)
The loan-to-value ratio is one of the critical points in the world of home loans because it describes your borrowing power. LVR is the amount you need to borrow calculated as a percentage based on the property lender-assessed value (value of the property).
Let’s assume the lender-assessed value of the property is $600,000. You currently have $200,000 as a downpayment. This means that you need to borrow $400,000 to be able to buy the property. Here is how to calculate the LVR:
$400,000 ÷ $600,000 = 66%
The above is an approximate percentage since it doesn’t include any possible additional fees that you might need to pay, but it gives you an understanding. Aiming your LVR to be as low as possible and not higher than 80% would be best. With a lower loan-to-value ratio, your property will have higher equity (market value of property minus the loan amount you still need to pay).
Interest Rate
The variable nature means that the rate may change depending on economic factors. A variable rate loan has the potential to save you money, but it’s essential to be prepared for potential interest rate rises. Rate changes are inevitable over the life of the loan.
Look at the rates offered by various banks and lenders, and find the one you will be able to continue paying even if the rates go up.
Loan Features
Unlike a fixed-rate loan, variable loans come with several features that allow you to pay the loan before the term, redraw funds, make extra payments, etc. Those features, however, may cost extra and increase your interest rate. Decide which features are important for you and which you can skip saving on your interest rate.
Comparison Rate
The comparison rate includes an interest rate, other fees, and additional features in the loan. It shows you the actual value of the loan because the interest rate alone doesn’t always give you an accurate picture.
Consumer Credit Code regulates the formula to calculate the comparison rate for all Australian financial institutions and mortgage providers. A comparison rate for home loans is helpful when you are trying to understand different loan packages and gives you an overview of possible hidden costs.
How High Will Variable Rates Rise in 2023?
The Reserve Bank of Australia (RBA) has been gradually hiking up their cash rates and will continue to do so in the next few years. All four big banks have cast their predictions, and the rates can go up to 6.61% by the first half of 2023.Given the predictions and the potential for rising interest rates, those with a variable rate home should be vigilant. There are certain actions you can take to save while the rates keep climbing. Consider making extra repayments now, redraw funds or change the loan if your contract allows you to do so without significant penalties.
When Will Variable Interest Rates Fall Again?
Following an increase of 25 basis points at the Reserve Bank of Australia (RBA) meeting in December, the official cash rate is now 3.10%. The rate has been steadily rising, and many homeowners and potential borrowers wonder when it will fall again.
Four major Australian banks have slightly different predictions about the financial situation. Commonwealth Bank is the most optimistic expecting the rates to fall in late 2023. NAB and Westpac forecast recession by June 2024. In contrast, ANZ expects the first rate cut to be in November 2024. With an ongoing war in Ukraine and many countries still recovering their economies after COVID, it is more likely that in 2023 we will not see the rates falling.
What is a Split Home Loan?
For those torn between the fixed vs variable home loan decision, a split home loan or split rate mortgage might be the solution. A split loan means part of your loan, the fixed portion, is subject to a fixed interest rate, while the other portion of the loan, the variable portion, is subject to a variable interest rate. For example, your total loan is $500,000. You can split it at 70:30 and pay $350,000 with a fixed interest rate and $150,000 with a variable one.
Splitting the loan can help you stay protected from interest rate spikes with a fixed interest rate and give you the flexibility the variable rate offers.
Fixed Vs Variable Rate Home Loans: Which One is the Best?
When choosing between a fixed rate and a variable home loan, or even considering a split home loan, weigh the pros and cons of both.. Fixed-rate loans are great for their stability and might be the right choice during the current period when rates are rising. Variable loans offer you flexibility and a chance to pay it out earlier and save significantly. Splitting the loan could be an excellent option to take advantage of the perks both types of loans can offer. Ultimately, the choice is yours. It will be easier if you consult with professionals who understand the market trends and can find the best option for you.
Contact Zanda Wealth Mortgage Brokers to Find the Best Home Loan for You
Looking for the right home loan can be overwhelming. In many cases, people don’t have enough time, resources, or knowledge to make the right loan decision and end up losing significant amounts.
Here at Zanda Wealth Mortgage Brokers, we want you to have your hands on your dream property minus the fuss! Be in touch with some of the best mortgage brokers in Australia and reach your property investment goals faster! You’re in good hands with us. Get started with a free strategy session today!
