When you take out a home loan, you have the option of choosing one with a variable rate or a fixed rate. As the name would suggest, a variable rate loan is one where the interest rate changes in line with the rates set by the lender. Meanwhile, a fixed rate loan is where the interest rate is locked in for a specific period, usually up to 5 years.
Pros and Cons of a Fixed Rate Loan
Choosing to lock in your interest rate has a number of advantages and disadvantages, which include:
1. Enjoying low interest rates longer. Interest rates are currently at record lows, with some lenders offering fixed rate loans at rates under 5%. With analysts expecting the Reserve Bank to raise rates this year, locking in your rate means that you will continue to enjoy the record low rates long after banks have raised theirs.
2. Having predictable mortgage repayments. With a fixed rate loan, you know exactly how much you’re going to pay every month, unlike in a variable rate loan where it may change depending on whether banks have raised or lowered their rates. This can be a positive thing if you want to have better control of your cash flow.
3. Possible huge jump in interest rates. Once the fixed rate period is over, you may be shocked to realise that there’s a huge difference in your locked in rate. This may then put you at risk financially, especially if you’re no longer able to afford the current rate. You can avoid this by doing your sums and raise rates by a factor of at least 2%. This will enable you to determine whether or not you can still afford your loan once rates go up.
4. Less flexible than variable rate loans. Another downside to a fixed rate loan is that this is usually less flexible compared to your other option. This means that you may be penalised if you make extra repayments on your loan, and there may be features found in a variable rate loan that you wouldn’t find in a fixed rate loan.
When to Lock In Your Rate
Depending on whom you’re listening to, you’ll likely find many analysts advising borrowers to lock in their rates because of the record low rates. However as we said earlier, if you decide to lock in your rates, you have to ensure that you will still be able to afford the loan once the rates go up. In addition, also determine whether or not you’re alright with foregoing some features that you can only find in variable rate loans, such as unlimited extra repayments per month.
Looking for a Suitable Loan?
If you’re looking for a loan that suits you best, it is recommended that you speak with a professional mortgage broker. They can provide you with assistance in comparing loan products and features based on your specific needs and your personal circumstances. For more details, please send us an enquiry today.
Written by Steve Milligan.