Taking out a home loan is a huge deal, and there are a lot of mortgage alternatives to sort through, so it’s no wonder many people become anxious about the process.
You may be familiar with the phrases “fixed mortgage rates” and “variable mortgage rates” if you have ever applied for a home loan or are now considering doing so. But what do they actually mean, and how do they impact the value of your home loan?
Understanding Fixed Mortgage Rates: Stability and Predictability
Let’s dissect the definition, workings, and advantages and disadvantages of fixed mortgage rates.
What Is a Fixed Rate Mortgage?
The concept of fixed mortgage rates is exactly what it sounds like—a loan with an interest rate that stays the same throughout a set period, regardless of market fluctuations. Simply put, this means you’ll know what your repayments will look like for the agreed term, whether it’s one year or ten.
Pros and Cons of Fixed Interest Rates
The main advantage of fixed mortgage rates is that your repayment rate stays the same over the years, no matter what. This means that your mortgage rate won’t be influenced by market interest rate changes or economic instability, which tend to spike interest rates in home loans.
However, as nice as this sounds, fixed mortgage rates have a few cons. For starters, fixed mortgage rates are often higher than variable rates. What’s more, a fixed rate means that you won’t experience higher rates but neither will you benefit from falling rates.
Also, if you sell or refinance your home while the loan is still set, the lender may charge you break costs to make up for their losses. Before committing to a long-term fixed rate, you should think about what you want to do with your home in the long run.
Fixed-rate loans often have limits, like not being able to make extra payments and not having an offset account. Most lenders will put limits on how much extra money you can pay back, which can lower your loan interest. Talk to your broker about a split loan if you plan to make big extra payments during your fixed term. This would mix both fixed and variable parts and give you access to an offset account.
Who Should Consider a Fixed Rate Mortgage?
Fixed mortgage rates are the best option for those who prefer stability and predictable payments. They’re ideal for homeowners who want to avoid the uncertainty of rising interest rates.
Exploring Variable Rate Mortgages: Flexibility and Potential Savings
Now that you understand fixed mortgage rates, let’s explore how it compares to variable rate mortgages.
What Is a Variable Rate Mortgage?
Unlike a fixed mortgage rate, which stays the same over time, a variable mortgage rate varies over time and in response to shifts in the benchmark rate, such as the Reserve Bank of Australia’s official cash rate.
This translates to a less predictable repayment plan, where your home loan’s interest rates can go up or down depending on market volatility. That’s why variable mortgage rates are also called adjustable or floating mortgage rates.
The Advantages and Risks of Variable Interest Rates
Since a variable rate mortgage clearly means less predictability and the potential for higher rates over time, you might be wondering if it has any advantages at all.
For starters, variable mortgage rates tend to be lower than fixed mortgage rates.
However, variable rate mortgages are riskier than fixed rate mortgages. If the Reserve Bank of Australia raises rates, your repayments will increase as well.
Who Benefits Most from a Variable Rate Mortgage?
Variable mortgages are a great choice for those with a higher tolerance for market fluctuations and who want to benefit from potential interest rate decreases. They’re also ideal for people planning to sell or refinance in the near future.
How Interest Rate Fluctuations Affect Your Home Loan
Interest rate fluctuations can have a significant effect on your home loan payments, especially for those with a variable rate mortgage. However, for fixed-rate mortgagors, these fluctuations won’t impact their repayments.
The Role of the Reserve Bank of Australia (RBA) in Setting Rates
The RBA sets the official cash rate, which influences the rates that banks offer on both fixed and variable home loans. When the RBA adjusts the cash rate, banks pass these changes on to borrowers. For variable rate mortgages, this means that if the RBA raises (or decreases) the cash rate, your interest rate and, therefore, monthly repayments could go up (or down). It’s also important to note that fixed rates are also linked to the bond market, not just the cash rate.
How Market Changes Can Impact Variable Rate Loans
Market shifts such as inflation, economic growth, or even global financial affairs can also affect your interest rates. During periods of extreme inflation, for example, the RBA could raise the cash rate to help curb expenditure.
When it comes to the real estate industry, you will also deal with factors like property demand or government policy changes that might indirectly influence bank variable rate setting.
The Difference Between Fixed vs. Variable Rates
The main difference between fixed vs. variable rates for your home loan is their impact on your monthly repayments.
Knowing a fixed mortgage rate can help you project your monthly repayment for the whole loan duration. This takes the pressure off changing interest rates from the picture.
Conversely, with a variable mortgage rate, you start with a lower interest rate that could change over time based on market stability, real estate demand, inflation, and other elements. Your monthly repayment quote will thus not be as consistent and may vary unexpectedly.
Choosing the Right Option for You: Fixed, Variable, or Split Loan?
You can get a mortgage with a fixed rate, a variable rate, or a split loan, which is a mix of the two. Split loans offer flexibility because, as the name suggests, they let you split your loan into a fixed portion and a variable portion. This could be a good choice for people who want the security of fixed payments while also wanting to benefit from variable rates.
Before deciding on the best mortgage option for you, think about your financial situation, how willing you are to take risks, and what are your long-term plans for the property.
Getting Professional Advice from a Mortgage Broker
You might not know whether a fixed mortgage rate, a variable mortgage rate, or a split mortgage rate is the best option for you.
This is why you should discuss your circumstances with qualified mortgage or financial brokers. Should you be a first-home buyer, they may also guide you on your eligibility for any first-homeowner incentive or concession.
Our staff of experienced Melbourne mortgage brokers at Loanscope can assist you to better grasp your home loan choices and guide you in decision-making.
