fixed vs. variable rate loans

The rate debate: fixed vs. variable rate home loans

Home loans generally have either a fixed or variable interest rate, or a split rate - a mixture of both. A fixed rate home loan is taken out for a set period with a set interest rate; when this period ends you can fix the rate again, or switch to a variable interest rate which fluctuates with the market.

Variable and fixed rate loans are more or less appropriate in different financial environments, and for different types of lender.

Fixed rate home loans

Fixed home loans have traditionally been associated with rigid conditions, but with flexible new products available, and interest rates relatively low, fixed rate loans are currently quite popular in Australia (though not as popular as standard variable rate loans). The majority of fixed rate home loans allow extra repayments and include redraw facilities.

A fixed rate home loan can be good if you want to carefully budget your repayment - knowing exactly how much you need to repay means you can plan accordingly and gives you a degree of certainty and security.

However, some fixed rate loans still charge you for making early repayments, which means that if your financial situation becomes more positive you will often have to either pay a fee, or keep the loan for the original term and pay the full interest amount.

If choosing a fixed rate loan, you also need to consider fairly carefully the term of the loan – usually between one and five years, but sometimes up to ten. The most popular fixed-rate loan term is three years - which seems to allow borrowers a sense of security with a certain degree of flexibility, but the choice of loan term needs to suit your specific situation.

Variable rate home loans

Variable home loans usually provide options and flexibility, but they can also be risky in a rising interest rate market if you’ve overcapitalized on your loan. The important thing to do when taking out a variable rate loan is to plan and budget for hikes in interest rates, and make sure that you’re able to meet your repayment obligations should rates rise.

Variable rate loans can include a range of extra features, and some loan products have low introductory, or “honeymoon” rates for an initial period before reverting to the standard rate. (More about home loan types.(

What do the experts say?

A number of experts suggest that fixed loans are a better option if there is an expectation of interest rate rises in the medium to long term. However, they also warn that the benefit gained may not be enough to counter the fees you could pay to switch from a variable to a fixed rate loan.

As with any home loan advice, the key is to examine your own financial situation, and only consider a change if the fees to make the change are outweighed by savings benefits.

Some experts point out that fixed rates rarely fall below the standard variable rate for a long period, and when they do it is usually a good idea to fix at least a part of your loan. Remember that you don’t have to fix all of your home loan, but you can split the loan between fixed and variable rates with a split rate loan.

Split rate loans: the best of both worlds?

A split rate loan allows you to split your loan amount between fixed interest and variable interest rates. This means that regardless of the economic situation your loan will be partially suited to it. However, it will also mean that you will be unlikely to receive the full benefits of a choice one way or the other.

Such a choice may suit your particular situation if you need some security, but also want the chance to pay off some of your loan ahead of time.

Choosing the loan that’s right for you

In the end your choice of a loan should be determined by your situation and your own financial priorities. It is difficult even for experts to make predictions about which direction interest rates will go in the long term – your choice needs to be made with your own financial goals in mind, and take account of your income stream and need for security or flexibility.