The recent cash rate hikes in Australia have made the choice between variable vs fixed rate mortgages more important than ever before. Homeowners who are refinancing are now forced to be more deliberate when choosing between the two.
On the other hand, first home buyers are also facing the same dilemma, as they try to determine which type of mortgage would be more cost-efficient for them in the long run. Given the fluctuations in the Australian real estate market as of late and the uncertain trajectory of the RBA cash rate, it can be challenging to decide which mortgage type is the right fit.
In this blog post, we’ll discuss fixed vs variable home loans in Australia and help you understand these two types of interest rates. We’ll also tackle the pros and cons of each so you can make an informed decision around this type of financial commitment.
What is a fixed rate?
A fixed-rate mortgage is a type of home loan where the interest rate remains the same for a specified period of time, usually between one to five years, regardless of any changes in the official cash rate set by the Reserve Bank of Australia or any other external factors that could impact interest rates.
Fixed interest rates revert to variable interest rates when the fixed-rate period ends. At this point the borrower can opt to renew their fixed rate for another term, or to switch to a different type of home loan product altogether.
Note that fixed rate home loans may come with certain restrictions or fees, such as break fees if the borrower decides to exit the loan early, or limits on additional repayments or redraws.
What is the variable interest rate?
A variable interest rate can fluctuate over time, based on changes in the official cash rate set by the RBA or other market factors. This means that the borrower’s repayments can also vary, making it harder to budget and plan for future payments.
Variable rate mortgages may offer more flexibility than fixed-rate mortgages. For example, many variable rate mortgages allow borrowers to make extra repayments without penalty or to redraw those extra repayments if needed.
However, variable rate mortgages can also come with some risks. For example, if interest rates rise, so too will the borrower’s repayments, potentially leading to financial strain.
Difference between a fixed and variable loan
Fixed rate home loan | Variable rate home loan | |
|---|---|---|
Interest rate | Remains fixed for a set period of time | Can fluctuate based on market conditions |
Repayments | Remains the same for the fixed period | Can vary depending on changes in interest rate |
Budgeting | Provides certainty and stability in budgeting | Can be harder to budget and plan for future payments |
Flexibility | May have restrictions on additional repayments | May allow additional repayments and redraws |
Interest rate | May be higher than the variable rate initially | May be lower than the fixed rate initially |
Risk | Protects against interest rate increases | Exposes borrower to interest rate increases |
Break fees | May be charged if exiting the loan early | May be charged if exiting the loan early |
Renewal options | May offer options to renew fixed rate term, or revert to a variable interest rate | May offer options to switch to a fixed rate or renew |
Factors to consider when choosing between a fixed vs variable home loan
- Interest rate environment: If interest rates are low, a fixed term loan may provide a level of certainty in repayments, while if interest rates are high, a variable rate loan may allow you to take advantage of potential rate cuts in the future.
- Budgeting and financial goals: If you prefer the certainty of a fixed repayment amount and are comfortable with budgeting for a set period, a fixed-rate loan may be more suitable. If you are more flexible in your budget and want to make extra repayments or take advantage of potential rate cuts, a variable rate loan may be more suitable.
- Loan features: Consider the features of the loan, such as whether there are any restrictions on extra repayments, redraws or early exit fees, and whether there are any benefits such as offset accounts or package discounts. Some borrowers may prefer a split loan, which combines a fixed and variable component, to provide a balance between certainty and flexibility.
- Personal circumstances: If you have a stable income and job security, a variable rate loan may be more suitable, as you can take advantage of potential rate cuts. If you have a more variable income or job security, a fixed term loan may provide greater certainty in repayments.
Risk tolerance: A fixed term loan provides greater certainty and protects against potential interest rate increases, while a variable rate loan exposes borrowers to potential interest rate increases but also allows for potential savings if rates decrease.
Which should you choose: Fixed rate VS Variable rate?
To provide insight on the fixed vs variable home loan conversation, I’m going to do a quick wrap-up on what’s happening in the market today. Note that the figures below reflect the ones that are reported at the time of this writing.
- The new customer rates for variable mortgages in the market are always a little bit cheaper than the rates for existing customers. Generally speaking, an average new customer rate in today’s economic climate will be somewhere between 5.2% to 5.3%.
- If we look at the fixed rates for 3-year fixed term loans, they would be about half a percent or 0.75% higher than variable rates in today’s market.
- The current RBA cash rate is 3.6% (as of April 2023). Banks and lenders have to make their margin and account for home loan buffer, hence their rates are always higher.
- According to the latest rate forecasting from RateCity, the current average rates are 6.36% which is obviously way, way higher than the rates mentioned above. (If your rates are anywhere near 6.36%, please come to me because these are not great rates at all — I can get you a better deal).
- The general prediction from the four major banks is that rates are going to go up by another half percent or even more. We are most likely going to see another one or two increases in the coming months. They also predict that the rates are going to start dropping towards either the end of this year or mid to late next year, at a rate lower than what we have at the moment.
- Current fixed rates are half a percent to 0.75% higher than the variable rates.
To put it simply, fixing is for peace of mind. With fixed rates, you will not have to worry about rate rises, plus they could be a good fit for you at the moment.
On the other hand, variable rates are currently cheaper, according to the big four lenders’ forecasts. As someone whose finger is always on the pulse of the real estate market, although variable rates are more volatile and can start to come up and drop back off again, my opinion is that I would be more comfortable sticking to variable rates.
All four major banks’s predictions seem to point to the direction of the cash rate and interest rates going down, and locking in at a high fixed rate now might not be in your best interest as this would let you miss out on more competitive variable rates in the market down the line. Personally, I would be happy to ride this one out.
Need help getting access to better rates? Q Financial has got you.
Here at Q Financial, we do our best to keep discounting all of our clients’ rates to keep them as competitive as possible. You can also ask me for tips and advice on how to best navigate the complexities around your home loan.
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