When considering a home loan, you'll need to decide between opting for a fixed interest rate or a variable interest rate. A fixed rate home loan can be a good choice when you’re finding your feet with a new loan – especially if it's your first home loan – and need some budgeting certainty.
Fixed home loan rates are usually for a short term only
You're most likely to be offered a five-year fixed home loan. Most loans which start with a fixed rate will revert to a variable rate for the remainder of the loan term after five years.
Advantages and disadvantages of a fixed rate home loan
- You have some certainty, making it easier to budget for repayments because the periodic repayment amount never changes.
- You're protected from interest rate increases – if rates rise elsewhere, you might find that you are paying a rate lower than the current variable interest rate
- Some fixed rate loans don't allow you to make extra repayments to pay the loan off sooner.
- If the lender's interest rates go down generally, you won't be able to take advantage of this because your rate is fixed.
- Fixed rate loans may have higher fees for making extra repayments (if allowed), higher switching fees (if you want to renegotiate some of the loan's conditions) and may not have an offset account or redraw facility.
- Most fixed rate loans are subject to a break fee if you want to pay the loan off before the end of the agreed term.
Advantages and disadvantages of a variable rate home loan
- Variable interest rate home loans are more likely to have a flexible repayment system, allowing the borrower to make extra repayments to pay the loan off earlier and pay lower total interest charges as a result.
- Variable rate home loans are more likely to have a redraw facility (giving you access to any extra repayments you made if you find you need the cash for another purpose) and a linked offset account (where you can park your spare cash to reduce interest charges).
- Refinancing a variable loan is usually easier and less expensive than refinancing a fixed rate loan.
- Your repayments on a variable rate loan will be lower if interest rates as a whole go down.
- It's harder to budget for variable home loan repayments, because they can go up or down at any stage during the term of the loan.
- If you are already financially stretched when you take out a variable rate home loan, you could end up in serious difficulties if interest rates increase.
Best term length for a fixed home loan
A typical term for the fixed rate period of a loan is between one and five years, even though your total loan term may be 20 or 25 years. You may, however, be able to get a fixed loan term of up to 10 years, or in a very few cases, 15 years, but you should consider very carefully (and get professional financial advice) before committing to a fixed rate for this length of time. A better option, if you are really sold on the idea of a fixed interest rate, would be to negotiate with the lender for another fixed term after the first fixed term ends.
If you've decided to start with the certainty of a fixed rate, it's probably a good idea to choose five years of fixed rates (rather than just one year, for example) to give yourself time to get used to the discipline of regular mortgage repayments. If you find you do have spare cash after meeting your repayments, you could put it into a savings account to act as a buffer in case find yourself in temporary financial difficulties, or leave it in an offset account (although you're less likely to have one of these with a fixed rate loan).