Fixed vs. Variable Interest Rate Home Loans

In Australia, there are two types of home loans that you can take out as a first-time home buyer: a fixed-rate loan or a variable-rate loan. Fixed-rate home loans lock in a set interest rate, and variable-rate home loans have a rate that moves in line with the standard variable interest rate.

What is a fixed-rate home loan?

A fixed-rate loan means your interest rate is fixed for a period of time, usually for the first one to five years of your mortgage, after which it reverts back to the standard variable interest rate.

How a fixed-rate home loan works

Fixed-rate loans are generally only available for up to the first five years of a mortgage before they revert to variable rates. In some rare circumstances, a bank may allow a fixed rate for the first 10 years of a loan. Banks generally only like to offer fixed loans for short timeframes as most people only want a fixed loan in times when rates are on the march.

Banks like to offer introductory fixed-rate terms to lock in new borrowers, so they’ll generally try to sweeten the deal with a very attractive initial rate. This is especially true of the big four Australian banks, which have had access to a relatively cheap cash rate for several years now. This can, of course, be advantageous for you as a first-time home buyer, but you should always pay careful attention to the terms and conditions of your mortgage and any penalties that may be associated with a fixed-term loan.

Pros and cons of a fixed-rate home loan

Fixed loan pros

Predictable repayments.
Protection from interest rate rises.

Fixed loan cons

No benefit if rates fall.
Break or exit fees may apply if you decide to end the fixed period of your loan.
Extra aggravation if you want to change to another lender.
Less potential access to redraw and offset account options.
No ability to make extra repayments (capped).

What is a variable-rate home loan?

A variable loan means your interest repayments are constantly moving in line with the standard variable interest rate. Put simply, if interest rates go up, so do your mortgage repayments, and if they fall, your payments should follow suit.

How a variable-rate home loan works

For example, if you have a mortgage for $300,000 over a 20-year period (with fees of $10) and the interest rate rises half a percent, from 5% to 5.5%, your monthly repayments will rise from $1,990 a month to $2,074 a month. Conversely, if the rate falls to 4.5%, your repayments fall to $1,908 a month.

Your home loan lender can adjust the variable rate at its discretion and is not bound to pass on all of a Reserve Bank of Australia’s (RBA) cash rate reduction, for example, but most of the time it will to avoid bad publicity and to move in line with other lenders.

Pros and cons of a variable-rate home loan

Variable loan pros

Ability to make uncapped extra repayments.
No break or exit fees.
Fewer interest payments if interest rates fall in your favour.
Ability to open offset and redraw accounts.
Greater simplicity in switching loans or loan types.

Variable loan cons

Interest rates could go through the roof.
Your repayments follow suit.

How to choose between fixed and variable home loans

Fixed and variable home loans come with a range of advantages and disadvantages.

A fixed loan can definitely protect you from the aggravation and uncertainty that accompanies interest rate increases by providing consistency for your repayments, even for a short period. As a first-time home buyer, you’re probably feeling quite risk averse, and given we appear to have entered a period of rate rises, a fixed-interest loan may seem like the best option.

On the flipside, a fixed loan means your options are greatly reduced because of the immovable nature of the loan, and you will be liable for fees and charges if you want to pay off the loan early, for example. You’ll also have no options for things such as a home loan redraw at a later date when you may need money you have accrued as equity in your mortgage for something urgent.

A variable loan, on the other hand, is not hamstrung by the restrictions placed on fixed interest rate loans, so you are free to make as many extra repayments as you like and are unlikely to be charged early repayment fees if you pay out your mortgage early in full. You will also benefit from lower interest rates if they go below the fixed rate and can enjoy generally greater mortgage freedom with options to move funds in and out of your mortgage account when you need to.

On the other hand, when interest rates are unrelenting and just keep on going in the wrong direction, your repayments will immediately follow suit. If you are thinking through when you should opt for a fixed-rate loan, it’s valuable to also consider a split loan, which includes variable- and fixed-rate components.

Mortgage Glossary and Home Loan Terminology

Confused by mortgage jargon? This glossary of home loan terminology includes words and phrases first-time buyers are likely to encounter in Australia.

Alan Hartstein