Fixed or variable and fixed rate loans – which is the best?
The past few months have seen a rapid rise in interest rates, and many property owners will be reviewing their finances, and may be looking at their loan options to see if savings can be made.
There are two types of loans, fixed or variable. The difference between these two types of loan ultimately comes down to how much interest is paid each month, but deciding factors of how much interest you pay is set by the Reserve Bank of Australia (RBA), and the lender’s terms and conditions.
Whether it is for a home or investment property, it is important to understand the differences between the different the two and look at the risks and benefits of both before deciding on what is best for you.
Fixed rate loans
This is a loan agreed on ‘fixed’ terms, ie where payments are held steady for a specified period. While the term of the loan may be for 20, 25 or 30 years, lenders are prepared to fix the rate of interest you pay for a set amount of time – usually between one and five years.
At the end of this fixed loan period of time, you can then decide whether to fix the loan again for another period of time at the current market rates or convert the loan to a variable interest rate for the remaining time left of the loan.
The pros of a fixed rate mortgage include:
- Repayments remain the same and generally do not rise if the official interest rate rises throughout the term of the mortgage
- Stability of a set amount going out each month, giving peace of mind
- Allows for more precise budgeting
The cons of a fixed rate loan include:
- If the interest rate falls, the repayments will stay at the same, higher locked in rate
- There may be fewer features, such as an offset account or a redraw facility, or even the ability to make additional payments
- There may be large penalties for an early pay out of the loan
Variable rate loans
As the name suggests, with a variable rate loan, the amount you pay each month will depend on the rates set by the RBA and the decisions of your lender whether to pass on the rate changes to the borrower.
As a result, your monthly payments could vary.
The pros of a variable rate loan:
- The monthly repayments may go down
- They often come with more features, such as the ability to make extra payments, be entitled to an offset or redraw facility
- If you have overpaid on your loan, and you are ahead on the repayment schedule, there maybe the possibility of taking a repayment ‘holiday’
- It may be simpler and easier to switch the loan to a variable rate
The cons of a variable rate loan:
- If the RBA increases the base rate, the repayments will go up
- It is harder to budget, particularly in unpredictable economic times
- You may struggle to meet repayments if there are several rate rises in a short period of time.
So now you know the difference, you probably now need to ask yourself a couple of questions:
- Do you want to play the market, or would you prefer the stability of a fixed rate?
- Is it financially beneficial for you to refinance given the costs involved to change a loan?
None of us have a crystal ball that can predict what will happen to the economy and interest rates in the future. The most important thing is to make informed decisions for your financial situation.
This is why we strongly recommend you seek the advice of a financial specialist, such as a mortgage broker or a direct lender who will talk you through the risks and benefits, and what to consider when choosing a loan.
Always ask questions if you’re unsure of anything and look at the small print before signing on the bottom line.
We do more than manage properties; having been in the business for nearly 50 years, we’re keen to share our knowledge and experience to help you make informed decisions and get the best out of your property.
Get in touch if you want to know more. Give us a call on 02 4954 8833, send us an email to mail@apnewcastle.com.au or pop into our Cardiff office for an informal chat.