How to decide: Fixed, split and variable home loan interest rates

How to decide: Fixed, split and variable home loan interest rates
How to decide: Fixed, split and variable home loan interest rates

Fixed, split or variable? Home buyers are always faced with the dilemma as to which is the best mortgage for their needs.

Interest rates being fickle, bank loan approvals usually take into account rate rises to make sure the repayment is still affordable, though in the end it still boils down to an individual's capacity to repay. 

The current low interest rate environment has translated to a growth in fixed loans. 

Let's look at each type of mortgage:

Fixed

The biggest advantage of fixed-rate loans is the predictability that comes with it, giving you some peace of mind as you are largely insulated from interest rate fluctuations. 

ASX-listed Mortgage Choice reported earlier this year that the demand for fixed rate home loans hit its highest level in more than 12 months, citing national home loan approval data, with fixed rate home loans accounting for 23.62 percent of all loans written in January, up from 19.44 percent in the previous month. 

But while considering fixed-rate loans, you must carefully consider the time period over which you would be comfortable with paying fixed payments.  

If interest rates drop during this period, you might end up paying more. Obviously, how much lower is the question. Because at present, RBA's cash rate of 1.75 percent is already at record lows.

The best aspect of fixed rate, however, is that it allows you to plan ahead as you already know how much to set aside for the mortgage payment each month.

The popular fixed rate products are usually around three to five years. 

Property Observer went looking for the cheapest fixed home loans on mozo.com.au and found that Illawarra Credit Union with an interest rate of 3.5 percent for the first year of mortgage was the one with the lowest rate. It was followed by Greater Bank at 3.79 percent, Illawarra Credit Union with 3.85 percent (for two years), loans.com.au at 3.99 percent and last Hunter United Credit Union at 3.98 percent. 

Fixed-rate loans come with a caveat. If you try to pay off your fixed-rate loan, fixed rate break costs and discharge fees apply.

If your home loan is fixed or if it was setup before July 2011, the exit fees can be significant.

So it may be worth considering a variable rate if your plan is to sell the property after some quickly realised gains. 

Some fixed rate loans include redraw facilities, and some have more flexible terms around repayments allowing you to pay extra up to a certain amount.

Variable

When it comes to variable rate loans, flexibility is the buzz word.

Variable interest rates tend to be lower than fixed rate products, and will have more features as well. However, they do come with an added risk, that of rising interest rates increasing your mortgage payments. So you need to be covered when interest rates rise.

If you’re borrowing less than you can handle, then you may decide that a variable rate is a good option in the immediate term – you can always fix later if necessary.

As of May 17, 2016, the top variable rates offered by lenders varied from 3.63 percent to 4.20 percent, according to mozo.com.au.

Independent lender www.mortgagehouse.com.au is offering a variable rate of 3.52% for the first six months, which then reverts to 4.02%. The lender also claims that it doesn't have expensive overheads unlike banks, which allows it to better customise its products and offer lower rates to customers.

Another advantage of variable interest rate home loans is that paying lump sums is easier with fewer associated costs than fixed rate loans.

If you know you cannot increase your repayments significantly, and there's a sudden vacancy in an investment property, then a rate rise can impact you. On the other hand, a rate cut will mean you could find yourself with a bit of extra cash on hand or paying off your mortgage sooner. 

Split

A 'split loan' is a comfortable compromise between the pros and cons of fixed and variable interest rate loans, according to a blog on the website of Suncorp Bank. A split mortgage allows you to reap the benefits of both the security of fixed rate loan and the flexibility of a variable interest rate loan. 

How it works is that you can allocate a portion of your loan amount to attract a variable interest rate, and another portion to a fixed rate, thus you have the security and the flexibility. The split may not necessarily be 50/50, it can be what you are comfortable with.

This provides you partial protection from future interest rate changes.

This may be a good option if you plan to pay off your loan earlier. The extra repayments you make can be solely done on the variable component of the loan.

However, you may have to pay the costs should you wish to break the fixed portion as that part is considered a fixed mortgage. 

As always, these are just rough guidelines and one should always consult a loan specialist to figure out which product is best suited to your needs.

Jonathan Chancellor

Jonathan Chancellor

Jonathan Chancellor is one of our authors. Jonathan has been writing about property since the early 1980s and is editor-at-large of Property Observer.

Tags: 
Interest Rates Home Loans

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