What’s the difference and how to choose which option is right for you
Home loans are one of the biggest purchases that a person can make. While it may be tempting to go for the most expensive option, you should be aware that home loans come with costs. The loan amount and repayment period will differ from lender to lender, but generally you can expect to pay between 3% and 7% interest on the loan. However, when you compare fixed vs variable interest rates, you need to make sure that you compare all the fees and charges included in the interest rate and make the best choice for your future.
The difference between fixed and variable loans
Fixed rate vs variable rate mortgages can be explained with one key difference. A fixed rate period is when your interest rate and therefore your repayments do not change throughout the life of the loan. Whereas a variable rate loan is when your interest rate can change over time and can continue to vary throughout the course of the loan – meaning your repayments can also fluctuate.
Fixed Rate Loans
Pros of a fixed rate loan
Fixed rate loans are popular because they offer you stability. You won’t be impacted by rate rises unlike variable rate loans. You know exactly how much your interest rate will be every month. The best part is the amount you pay won’t change for the life of the loan which can make it easier for you to budget for. When you sign up for a fixed rate loan, you can set an automatic transfer from your checking account to your fixed rate loan account to pay off the balance each month. Simple and easy!
Cons of a fixed rate loan
With a fixed rate mortgage (FRM) the interest rate and your payment remain the same throughout the life of the loan. A fixed rate mortgage is usually a good choice if you plan to stay in your home for a long time. With choosing a fixed interest rate, the amount you pay in interest depends on your loan term. This means that when you have a shorter loan term, you pay more in interest than if you had a longer loan term so in this instance a fixed rate can be more costly.
Variable Loans
Pros of a variable rate loan
When it comes to financing a home, many people are reluctant to consider the idea of a variable interest rate. This is understandable, as most people think that they will only be able to get a fixed interest rate for a long period of time. However, there are several reasons why you might want to consider a variable interest rate loan. The most common benefits include:
- Having ability to change the loan amount and repayment frequency
- Paying off the loan faster with additional repayments
- Receiving the lowest interest rates possible
- Making fewer monthly payments
- Utilising an offset account
Cons of a variable rate loan
A variable loan is a loan in which the interest rate fluctuates as time passes. Because of this, it can make the repayment of the loan more difficult as it can lead to a higher overall cost over the term of the loan. The biggest downside is that the amount and the term may change after you have applied for a variable interest rate meaning when rates drop, it may be too late to refinance so overall you may end up paying more interest on a variable rate loan than if you had a fixed rate loan.
Is it better to have a fixed or variable loan?
The best rate is the one which works best for you and your future. Typically, first home buyers, with less equity in their home, might prefer a split rate home loan so they can get the best of both options. As the old saying goes, “The best mortgage is the one that you can afford to pay off.”
If you decide to get a variable interest rate mortgage over a long term, you may essentially pay more than you need to. To keep within a budget and not go over, you should consider having a fixed interest rate which allows you to have a set payment and gives you peace of mind as you can simply ‘set and forget’.
Split loans
A split loan is when you take advantage of both a fixed rate loan and a variable rate loan at the same time by splitting your mortgage into two loans. The advantage of a split loan is that you can pay off one part at a time and save interest in the process. By splitting your home loan, you can not only save thousands of dollars in interest, but it can also soften the blow if the fixed portion expires during a period of increasing interest rates.
Check out our blog that outlines how a split loan allows you to take advantage of the benefits of both variable and fixed rate loans.
Conclusion
If you have been thinking of buying a home, you’ve probably heard a lot about how important it is and that buying a home can be an excellent investment in your life, but it’s also much more than just that. Buying a home can be the beginning of many wonderful experiences.
The best thing you can do when looking to buy your first home, or when refinancing an existing home loan is to discuss your options with a mortgage broker to understand your options and decide what will work best for you and your future. If you need help, reach out to book an appointment with Mike Mackenzie.