Should you fix your home loan?
When it comes to securing a home loan, your first port of call is always a mortgage broker. A mortgage broker works with various banks to review the best home loan for you and will assist you to submit all of the paperwork and get the loan approved.
As part of the process, the mortgage broker will ask you whether you want your loan to be fixed, variable, or some combination of both.
Whilst the mortgage broker may have some ideas of what may suit you, it’s important to remember that they don’t understand your long-term financial plan. This is where a financial planner can assist.
What is the difference between a fixed and variable loan
In order to make an informed decision, you first need to understand the difference between a fixed and variable loan.
A fixed loan is one where the interest rate is fixed in for a period of time. For example, you may fix your loan at 2.5% for 5 years. This will mean that regardless of what happens with interest rates generally, your interest rate will remain at 2.5% for the length of the fixed term.
A variable loan on the other hand is a loan where the interest rate can change at any time. Lenders may increase or decrease the interest rate when they choose and may change this in response to decisions of the Reserve Bank of Australia, as well as other factors.
If interest rates do go up, usually your required minimum repayments will increase and if it goes down, they will likely decrease.
These rates don’t change each payment. Instead, when an interest rate change occurs, the bank will write to you informing you of your new payments.
So which one is cheaper, fixed loans or variable loans?
Whether a fixed loan or variable loan is cheaper depends on what is going on with interest rates in the world.
In the past, fixed rates were commonly higher than variable rates. This hasn’t been the case for a few years with fixed rates now commonly being cheaper.
From your perspective, it can be appealing to go for the one with the lowest rate. Particularly if you believe interest rates are going to rise. Not only are you getting an initially cheaper rate, it will remain cheap whilst variable rates rise.
But there is a catch.
Disadvantages and advantages of a fixed loan
The biggest disadvantage I see with a fixed loan that is often overlooked is the restrictions on making additional repayments to your home loan.
Most fixed loans either don’t allow additional repayments or limit how much you can make to the loan. They also don’t allow you to have an offset account where you can keep your money and reduce the interest payable.
This can be a big deal and for those who are good at saving, can mean you end up paying a lot more interest than if you went with the slightly higher variable rate.
The trade off however is the certainty of the rate and if its lower than a variable rate, the discount provided on your interest repayments.
A fixed loan also can prevent you from changing banks for a cheaper deal if you are still within your fixed period (without incurring a break fee). This can be an issue if you decide to move or need to sell your house abruptly (for example if a marriage breaks down).
So should you have a fixed loan or variable loan
I make no secret of the fact that I like saving money. If a fixed loan is cheaper than a variable loan and you think that interest rates aren’t going to drop, then it makes sense to fix at least some of your loan.
I would however suggest making sure some of it is variable so you can pay it down quicker. Preferably you would get an offset account so that all of the money you have saved is offsetting the interest.
When considering how much to fix, think about how much you can save in the fixed period. For example, if you have a fixed period of 5 years, then consider the best case scenario of how much you can save and ensure that is a variable loan (with an offset account attached).
As always, if you have any questions, please reach out. Whilst we aren’t mortgage brokers and won’t recommend loans, we can discuss how structuring your loan will fit into your greater financial plan.