One of the key decisions in selecting a home loan is the choice between a fixed or variable rate.
In today's low rate environment, it can be tempting to lock into a low fixed rate but it's important to understand how fixed and variable rates work to be sure you make the decision best suited to your needs.
Fixed rates are closely linked to prevailing conditions in the money market, so at times, fixed rates can differ quite considerably from variable rates. Once a borrower has locked in a fixed rate loan, they will start paying the fixed interest rate straight away and remain on that rate for the duration of the fixed term – regardless of how variable rates move.
With this in mind, part of the decision to lock into a fixed rate should involve taking a view on how variable rates are likely to change over the selected fixed term. With interest rates currently hovering around record lows, it is fair to assume that interest rates will rise eventually. That said, the Reserve Bank of Australia has recently made it very clear that the most prudent course of action for the moment is a period of stability in interest rates.
In reality though it is very difficult to accurately predict exactly how variable rates will behave. This is important because the longer the fixed term you choose, the harder it becomes to second guess the likely direction of variable rates.
Look beyond a low fixed rate
This uncertainty over interest rate movements makes it important to consider the other aspects of a home loan beyond a compelling fixed rate. For example, is loan flexibility important to you, or is certainty of repayments more critical?
Variable rate loans do tend to be more flexible, often with a wealth of features like a redraw facility, the ability to make extra payments and the option to have an offset account. Fixed loans are becoming more flexible but many fixed loans typically still do not offer these sorts of features.
Break costs can apply
Importantly, if you want to end (break) a fixed rate loan before the original term expires, you may face significant extra expenses known as break costs. It can be difficult to quantify exactly what these costs could be as they tend to hinge on how market rates have changed since you entered a fixed rate loan. But in the worst case scenario the cost can potentially run into thousands of dollars.
Weigh up the pros and cons
The bottom line is that while many fixed rate loans are offering inviting deals, it makes good sense to weigh up every aspect of the loan.
Your Mortgage Choice home loan expert can help you work out the potential outcomes of different fixed and variable interest rate scenarios as they apply to your situation. Or take a look through our fact sheet on Fixed versus variable interest rates for more information on what's involved.