With interest rates at an all-time low, many people start wondering is now the right time to fix my loan? Will interest rates continue to drop or will they start to rise?
Let’s face it; interest rates are cyclical. While they might be at historic lows right now, there are always points in the economic cycle when they may start to rise again. The threat of being caught in a series of interest rate hikes is often enough to prompt many home owners to jump over to a fixed loan.
Before you make a decision either way, take some time to weigh up the pros and cons of each option. Here is a quick look at the benefits and disadvantages of both fixed and variable interest rate mortgages:
Variable Rate Loan
A variable interest rate mortgage is a loan where the interest rates can fluctuate in line with the cash rate. Of course, there are also occasions when banks can raise or lower the interest rates even when there are no changes from the Reserve Bank.
Benefits of a variable loan
When your mortgage is on a variable interest rate, the interest you pay can fluctuate at any time. If interest rates go down, your repayments will also reduce. However, if interest rates start to climb, you can expect your repayments to increase accordingly.
Many variable rate mortgages are quite flexible. You have the freedom to make additional payments, which helps to repay your mortgage faster. There are also no penalty fees for paying extra off your home loan balance. Some banks also offer a redraw facility, which allows you to redraw any additional payments you’ve made.
You may also choose to link an offset account to your variable rate mortgage. An offset account gives you the opportunity to reduce the amount of interest that can be charged on your remaining balance.
Disadvantages of a variable loan
While variable loans offer lots of flexibility, there are also some disadvantages to consider. Perhaps the biggest drawback is that your repayments will increase if interest rates go up. If you’re on a tight budget, it can be challenging trying to keep up with payments when they start to rise.
Fixed Interest Rate Loan
A fixed rate loan allows you to lock in your interest rate for a predetermined period of time. Most banks offer fixed interest rates for varying terms. You can choose to fix your loan for 1, 2, 3, 4, or 5 years, although there are some banks out there that may let you fix for up to 10 years.
While locking in your interest rate can be a good idea for some people, always take into account the benefits and drawbacks before you make a decision.
Benefits of a fixed loan
During the fixed rate term, your interest rate can’t be affected by any fluctuations in the market. This means your payments also won’t change during the fixed term. You’ll know exactly what your monthly payments are, which can make your budgeting easier.
It can be tricky to know how long to lock in your mortgage for. Most banks offer very competitive interest rates for 2 and 3 year terms. However, the 5 year fixed rates tend to be a little higher in comparison, simply because the banks tend to hedge their bets against future increases in the cash rate.
Many first home buyers and families can find it reassuring to know that repayments won’t change for a certain period of time. If the variable rates start to rise, you have the peace of mind that you won’t be affected while you’re protected by your fixed rate loan.
Some investors may also find the certainty of a fixed rate reassuring. Locking in the interest rate for a period of 2 or 3 years can mean knowing the payments remain the same. However, the rental income may increase over the same period of time, which could help to improve your cash flow.
Disadvantages of a fixed loan
While the advantages of locking your mortgage into a fixed rate might be tempting, it’s a good idea to remember there are also some disadvantages to take into account.
When you agree to lock your mortgage into a fixed rate term, you may need to pay hefty break fees if you choose to change the loan before the end of the term. For example, if you switch back to a variable rate, refinance your mortgage, or sell your home during the fixed rate term, break fees may apply.
In some cases, the bank may also charge you break fees if you make substantial additional payments throughout the fixed term. Many banks will place limits on the maximum extra repayments you can make each year. In many cases, the limit is between $5,000 and $20,000.
It’s also worth noting that the fixed rate offered by many banks is often higher than the variable rate. If the variable rate drops, you’ll miss out on reaping the benefits of reduced payments.
In most cases, an offset account is not available to fixed loans, but there are some lenders who will offer a partial offset during the fixed term. Some banks may also not allow you to redraw any extra payments you’ve made until after the fixed term has ended.
If you’re unsure whether to choose a fixed or variable loan, it is possible to split your mortgage and take advantage of both options. You can keep a part of your mortgage variable to take advantage of the flexible options and fix the remaining part to take advantage of locking in a low interest rate.
No one can accurately predict how interest rates will move. Likewise, your individual financial situation isn’t the same as anyone else’s, so what works well for one person might not suit your financial goals.
The best way to check which option might work best for your financial circumstances, your budget, and your goals is to discuss your home loan type and structure with a mortgage specialist.
Call us today on 1300 832 554 or click here to request a FREE Home Loan & Finance Structure Health Check.
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Disclaimer: We recommend that you seek independent financial and taxation advice before acting on any information in our articles and newsletters. They contain general information only and have been prepared without taking into account your personal objectives, financial situation or needs. We recommend that you consider whether it is appropriate for your circumstances. Your full financial situation will need to be reviewed prior to acceptance of any offer or product. Interest rates are subject to change without notice. Lenders terms, conditions, fees & charges apply.