Fixed rate interest loans vs. variable interest rate loans – what are the pros and cons of each?

This can often be one of the most difficult decisions to make when taking out a home loan and there are many arguments for and against both fixed and variable interest rate loans. Do I fix my interest rates to take advantage of the low interest rates or do I go with a variable interest rate loan to allow for flexibility? It is a common question we hear as mortgage brokers and there really is no simple answer as it depends on your personal circumstances.

When you take out a home loan, you will generally have a choice between a variable rate or a fixed rate loan. With the record-low rates at the moment, lenders have begun to cut their fixed rates to levels never seen before. Because of that, this type of loan has become more attractive than it has been in the past. So, now for the common dilemma: which is more suitable for you, a fixed rate or a variable rate loan? Let’s weigh the pros and cons of each one.

The Pros and Cons of a Variable Rate Loan

Probably the biggest advantage that a variable rate loan offers is flexibility. This type of loan usually allows you to make extra repayments on your loan without any penalties or additional fees and charges. This feature may be important to you if you want to pay off your loan sooner since you may be able to pay off larger amounts of your home loan, such as when you receive a bonus at work.

The downside in a variable rate loan is, as the name would suggest, the fact that rates move along with the movement of the rates in the market. So, if the Reserve Bank finally decides to raise rates, your interest repayments will also become more expensive in the process. Connected with that is the inherent unpredictability of your monthly repayments since your repayments may go down or up depending on the prevailing rates. This can make managing your household budget a bit more challenging.

The Pros and Cons of a Fixed Rate Loan

People usually choose a fixed rate loan because it lets them enjoy the rates that they want longer. In general, lenders can offer up to a five-year fixed rate period. This means that if you’re paying an interest of 4.5 percent right now, you’ll still pay the same rate even if rates rise eventually during your fixed rate period. This makes budgeting for your loan repayments more predictable.

Fixed rates are also less flexible than variable rates and because of that, you may be penalised by your lender if you make extra repayments or there may be features that you won’t be able to enjoy since they’re reserved for variable rate products.

How to Choose a Suitable Loan

Some important questions you have to ask yourself when choosing between these two types of loans include whether you prefer predictability or affordability, and how soon you plan on paying off your loan. If you want to make your monthly repayments consistent and know the exact figure you’re paying each repayment, then it may be more advisable for you to take out a fixed rate loan. If you’re looking to pay higher repayments to help pay off your loan sooner while you can afford to or want the flexibility then a variable rate option may be more suitable.

If you’re still undecided on what type of loan is right for you, a mortgage broker can assist you with this. They will ask you specific questions about your personal circumstances and preferences when it comes to loans to find the most suitable loan. You’ll have a better chance of finding a suitable loan with a broker because they already have a network of lenders to choose from, which allows them better insight into their loan products.

If you or someone you know is looking at taking out a home loan, speak to one of our experienced brokers about your options to take the trouble out of timely research and find the right loan product for your personal situation.

Written by Tiffany Gourlay.