Navigating the mortgage and home loan space can be a daunting task. Not only is it important to consider which lender is going to be right for you and how much you should borrow, but you also have the added consideration of whether you should fix your loan, keep it variable or split your loan and take advantage of the benefits of both.
This week our team at Loansuite is exploring the pros and cons of fixed, variable, and split loans so that you can make an informed choice about which option might be right for you.
With a fixed-rate loan, the interest rate payable will generally not change for the fixed period. This can be advantageous for you as a borrower if variable interest rates are rising as it provides some cash flow and budgeting certainty. The fixed period could be anywhere from 1 through to 10 years, and in some countries can be even longer.
It’s important to consider where you see rates heading in the future when you’re considering whether a fixed rate is right for you, as well as how long to fix your interest rate for. If you expect rates to increase in the short to medium term, you may be better fixing for a slightly longer period.
- Budgeting & Cash Flow Certainty: With a fixed-rate loan, you know exactly what your repayments are going to be for that fixed period. You don’t need to be concerned at all if the interest rates were to be lifted by the RBA as this wouldn’t impact your loan.
- Lower Rates: At this current point in time, most fixed-rate loans are at a lower rate than variable loans, which can create some additional savings for you. These discounts can be up to 1%, which could be a significant saving for you if you have a reasonable size mortgage or home loan.
- No Offset Account: Most lenders will not allow for an offset account against a fixed-rate loan, which may be a detractor for you depending on your circumstances. There are some lenders, such as CBA and Bankwest at present, which will allow for a partial offset account, however, this is usually capped at 1/3, meaning that for every $100 in your offset account, the loan balance you’re charged interest on would be reduced by $33.33.
- Limited Additional Repayments: Most lenders will cap your ability to make additional repayments into the loan during the fixed period. This is typically capped at $10,000 during the fixed period above and beyond your minimum requirements repayments.
- Break Fees: A fixed-rate loan will have break fees if you decide to opt-out of your fixed-rate loan prior to the fixed period expiring. This can be quite expensive, so it’s important to do your homework here and ensure that the period you’re fixing the rate for is aligned with your financial goals.
With a variable rate loan, the interest rate payable will change as the cash rate is changed by the Reserve Bank of Australia (RBA), or other factors push interest rates up or down over time. The bank may decide to adjust rates at their own discretion based on the underlying cash rate set by the RBA, however, the direction will usually be consistent.
- For example, if the RBA decided to increase the official cash rate by 0.25%, then it is likely that most Australian banks and lenders would increase their variable rates by up to 0.25%. They may not pass on the full increase to borrowers, however, and you may find that they increase their rates by just 0.15 to 0.2%. You’ll often see commentary about which lender will be the first to adjust their rates following any adjustments made by the RBA.
- Flexible Additional Repayments: Most lenders with a variable rate loan will allow you to make additional repayments freely above and beyond your minimum required repayments, which may allow you to repay your loan faster.
- Offset Account: With a variable rate loan, many lenders will allow you to attach one or multiple offset accounts to your home loan or mortgage, which may allow your excess cash and even emergency fund to be working harder for you.
- Rate Discounts: Many lenders will allow mortgage brokers to request a pricing discount for you as the borrower on their variable rate loans. This is often not the case with fixed-rate loans.
- The volatility of Interest Rates: With a variable rate loan, you will be exposed to any changes made by the RBA to the official cash rate, which would likely be passed onto you by your lender. This may make your budgeting and cash flow forecasting slightly more difficult.
A split loan refers to a situation where you utilise both a variable and a fixed loan and split the overall loan into two or more accounts. For example, if you had a total loan of $500,000, you may decide to fix $250,000 of this and keep the remaining $250,000 as a variable loan. This would mean that you have two loan accounts here, so let’s explore the pros and cons of such a setup.
- Best of Both Worlds: By splitting the loan, this allows you to take advantage of the benefits of both fixed and variable loans. For example, this may mean that you can take advantage of the lower rate with the fixed loan for a portion of your loan, while still attaching an offset account to the variable component.
- Additional Repayments: With the split loan, you can utilise the variable component to make additional repayments to this particular loan account, while staying within the rules of your fixed loan.
- Multiple Accounts: A split loan will mean that you will now have multiple accounts, which can mean slightly more work for you to track your loan balances and repayments on a regular basis. With the aid of internet banking these days, this is unlikely to be too much of an issue for most people.
- Account Fees: With some lenders, they may have a fee per loan account that you have with them, so it’s important to check out what your lender offers and ensure that you’re not unnecessarily paying too much in bank fees.
- Break Fees: One of the drawbacks of a fixed-rate loan is of course the break fees if you wish to refinance the property before the fixed period ends. This could also be the case if you decide to sell the property before the fixed loan has expired.
As you can see, there is no one size fits all approach to selecting the right home loan for you. It’s important to speak to an investment-savvy mortgage broker who can explore all of the options for you and structure your loan in the right way.
LoanSuite Pty Ltd is your lending partner for all of your home loan, investment property, business and commercial financing needs. With our wide range of lending solutions, expertise in financial planning and investment strategies, and extensive experience in working with both Australian residents and Australian expats, we are your partners for your lending needs.
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LoanSuite Pty Ltd is an Authorised Credit Representative (Credit Representative Number – 494608) of My Local Broker (Australian Credit License – 481374). Important Disclaimer: Your complete financial situation will need to be assessed before acceptance of any proposal or product.