Variable Rate Loans

If you choose a variable mortgage, the interest rate charged moves up or down in line with the cost of bank funding. This may be affected by the official cash rates set by the Reserve Bank of Australia. So, if they go up, so do your required repayments, but if they fall, then you can pay less each month.

A standard variable home loan offers you flexibility, with many offering features such as redraw facilities and cheque books, and the ability to make lump sum payments or transfer your loan to another property in the future.

A basic variable home loan is generally about 0.5% cheaper, but it's the "low cost, no frills" version with few added services..

The Good Points

ü  Your home loan repayments will fall when interest rates fall

ü  You will have the opportunity to reduce your home loan balance faster

ü  Can be very flexible and will often allow unlimited additional repayments

ü The average variable interest rate is generally lower than a fixed home loan rate

The Bad Points

û Your home loan repayments will rise when interest rates rise. If interest rates rise quickly, your home loan repayments over a certain period of time may be more than those of a fixed interest rate home loan over the same period of time If you have borrowed at or near your repayment capacity, it is risky if interest rate do rise

Fixed Rate Loans

Fixed interest rate home loans offers you a fixed interest rate – so you have a fixed repayment amount – over a set term, usually between 1 and 5 years. The most commonly used fixed interest rate term in Australia is 3 years.

A fixed interest rate home loan is set by your lender; they borrow money from the wholesale money markets and then ‘sells’ this on to you. The cost to the lender of borrowing this money is determined by what the money markets believe interest rates will do over a set term. Your lender will then add a margin to this, the final interest rate is then offered to you for the fixed term you are applying for.

The Good Points

ü You will know how much your loan repayments will be for a fixed period, regardless of market interest rate changes

ü Protects you against interest rate rises

ü You can pick the time period to suit you; fixed terms are available from 6 months to 10 years

The Bad Points

û May be less flexible than a variable home loan rate, limiting additional repayment options and excluding the option to redraw

û If your circumstances change and you want and/or need to exit the loan early, early exit fees will apply

û Over the term of your loan you may end up paying more than if you had selected a variable home loan, even in a rising interest rate market

Use a combination of fixed and variable rate loans to your advantage

You don’t have to choose just a fixed home loan rate or a variable home loan rate, there are some options available that help you to minimise how much home loan interest you might pay.

One common option is to split your home loan so that it is part-fixed/part-variable. A single split between fixed and variable is most common, but in some cases you may be able to split your home loan a number of times e.g. part-variable/part-fixed for one year, part-fixed for three years.

Another option is to choose a variable interest rate home loan, but make your home loan repayments at the same level they would be if you had chosen a fixed home loan rate. This works well when variable interest rates are much lower than fixed interest rates by helping you to reduce your principal debt. You will reduce the length of time it takes to repay your loan and also the total amount of interest charged over the life of the loan.

There is also the added benefit that, if you really need it, you can redraw some of those additional repayments at a later date, something you can rarely achieve with a fixed home loan rate.