Mortgage interest rates have been steadily rising over the past few months, with more increases predicted to come. Home loan borrowers are naturally worried about their increasing costs, and many are rushing to lock in a fixed rate to avoid the impact of multiple rate hikes on their household budget. But whether or not it will save them money is questionable.
What is the difference between fixed and variable rate home loans?
A fixed-rate home loan gives you the security of fixed repayments for a specified period, usually up to five years. If you are looking for stability or find it hard to deal with the stress of changing interest rates, fixing your home loan can give you the peace of mind that your repayments will not change for some time. On the downside, fixed-rate home loans are not very flexible, and you are likely to incur expensive fees if you wish to prepay your mortgage or refinance during the fixed term.
If you choose a variable rate home loan, your repayments will fluctuate over time, generally in line with the official cash rate set by the Reserve Bank of Australia (RBA). This means your repayments will increase when the cash rate rises, but you are also likely to benefit from any rate cuts announced by the RBA.
Variable rate home loans are also more likely to offer flexible repayment options, such as allowing you to make extra repayments or providing you with an offset account to park your money and save interest. While these features and benefits may not be free, they could help you manage your home loan costs by allowing you to reduce the interest you pay.
Pros of fixing your home loan:
- Fixing your home loan means you’ll know exactly how much to pay each month.
- Fixing your home loan protects you from market fluctuations, which can give you a sense of stability or peace of mind.
- It’s easier to budget when you have to make fixed repayments.
Cons of fixing your home loan:
- While a fixed rate protects you from market fluctuations, you don’t benefit if the rates go down.
- Fixed-rate home loans don’t generally offer a 100% offset account facility or even allow you to make additional repayments.
- Refinancing your loan or closing it before the end of the fixed period may attract break fees and other charges.
Pros of variable rate home loan
- Variable rate home loans are generally more flexible; you can refinance at any time without incurring any break costs.
- Many variable rate home loans offer helpful features to manage your home loan like free additional repayments, 100% offset account, repayment holiday, and mortgage porting.
- You can potentially save money with a variable rate home loan in a low rate environment, but you’ll also pay more in the reverse scenario.
Cons of variable rate home loan
- Your repayments will fluctuate when you opt for a variable rate home loan, making it difficult to plan ahead.
- Interest rates can go up (as is happening now) at any time, increasing your monthly repayment size.
Should you switch to a fixed-rate home loan or continue with a variable-rate home loan?
If you are worried about the increasing interest rates, you may be looking to fix your home loan to shield yourself from the rising interest rates for some time. A fixed-rate home loan locks your interest rate for a period, allowing you to make the same monthly repayments in that time. Knowing how much you need to spend on your home loan each month also makes it easier to plan your household budget, reducing the risk of defaulting on your repayments.
But there’s a downside to fixing your home loan rate – you could see your interest rate increase if you switch to a fixed rate now.
According to the RBA statistics, the average variable interest rate on outstanding home loans was 2.78% in May 2022. Fixed-rate home loans are more expensive in comparison, with interest rates as high as 5% or more if you want to fix your rate for more than three years. While that doesn’t mean you shouldn’t fix your home loan – whether fixing will save you or not money will largely depend on your current interest rate and the fixed rate you choose. To make an informed decision, you should calculate how much money you’ll save by fixing your home loan if the interest rate predictions were to come true.
You should also explore other strategies to manage your home loan repayments, such as refinancing to a lower interest rate or using an offset account to reduce your monthly interest. Even though interest rates have risen over time, there’s no harm in comparing home loan deals to check whether you’re on the best rate possible. If not, you could try to negotiate a lower rate with your lender or consider refinancing elsewhere.
The money you save by switching to a lower rate can be paid into your mortgage to reduce the outstanding debt faster. Cutting down your interest rate by a few basis points could also shield you from the effect of a subsequent rate hike. But remember refinancing costs money, which could eat into any potential savings. Therefore, it’s important to calculate the costs and the savings you expect to make after refinancing to ensure you don’t end up financially worse. A mortgage broker can help you crunch the numbers and explain the pros and cons of different situations to help you manage your home loan better.
