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Content team at Justprop.com.au,

Fixed Loan Vs Variable Loan - What is best for you?

5Mo ago 0 Replies 148 Views
A common question among home buyers is whether fixed rate or variable home loans are best.
Like most decisions in investing or buying property, there is no clear cut answer.
And as no one can know exactly what will happen to interest rates over the period of a loan (which has a significant impact on loan repayments), it’s important to understand and weigh up the pros and cons in order to make an informed choice.
Fixed term home loans
With a fixed rate home loan, the interest rate is ‘fixed’ for a pre-determined period of time. This period is usually between one and five years, with three years being a common option. After this fixed term, it usually then changes to a standard variable rate offered by that lender. The rates for fixed term loans are based on what the interest rate is expected to average over the coming years.
Pros
  1. There is more certainty with this type of loan. The borrower will know exactly what their regular repayment will be for the fixed term
  2. It allows for easier budgeting
  3. The borrower won’t be affected by any interest rate rises
  4. There is peace of mind with this type of loan that payments won’t suddenly increase
  5. There is generally less mortgage stress

Cons
  1. The borrower will not benefit from any rate cuts
  2. A redraw facility may not be available with this type of loan
  3. The mortgage holder generally can’t make any extra voluntary repayments, or if it is allowed, it’s capped at a very low amount
  4. Because of this, it’s generally harder to pay this type of loan off sooner
  5. Less flexibility – the borrower is locked in for that fixed term, meaning it is harder to change loans or lenders or shop around for a better deal. If the borrower wants to leave or change, fees generally apply for doing so
  6. This type of mortgage may not be appropriate if the homeowner is planning to sell any time soon, as break fees generally apply. Alternatively, this is when a shorter fixed term period (one year) may be a suitable option.

Variable home loans
A variable rate home loan moves with market interest rate changes. As it is based on the current interest rate, repayments will fluctuate – they will either increase or decrease, depending on the official cash rate – over the term of a loan.
Pros
  1. Mortgage holders will benefit from any rate drops, meaning a reduced repayment amount at that time
  2. This type of loan generally allows for extra voluntary repayments, meaning it can be paid off sooner
  3. It is easier to switch to another loan or lender or sell the property without being penalised
  4. There are often extra perks or features including unlimited redraws and the option to set up an offset account

Cons
  1. Borrowers will be affected by interest rate rises
  2. Loan holders may have trouble meeting repayments if interest rates increase dramatically.
  3. There is more uncertainty with this type of loan as there is no definite repayment amount. This can make it harder to budget and plan in advance
  4. There can be more mortgage stress with this type of loan
  5. Lenders may not pass on rate cuts in full to borrowers, meaning they won’t get the full benefit of rate drops
  6. Split loans
  7. Rather than putting all their eggs in the one home loan basket, home buyers can take advantage of a split loan if they wish. This means that part of the loan can be fixed while the other is variable. This could be a 50:50 split, a 70:30 split, or whatever balance best works for that buyer.
Some advantages of opting for a split loan include:
  1. It’s a good way to hedge your bets and take advantage of the benefits of both approaches
  2. There’s an amount of protection against rate rises (only the variable portion of the mortgage will be affected), while the mortgage holder can still benefit from any rate drops (the variable portion will reduce)
  3. Some lenders will offer a discounted rate to take this approach
  4. Borrowers can choose to pay off the variable amount sooner if they wish
  5. It’s generally more flexible than a straight fixed term loan.
  6. As always, those choosing between home loans should consider the advantages and disadvantages of each approach and take into consideration their own needs and financial strategy when choosing what home loan is most appropriate.


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