Fixed vs Variable Interest Rates: Home Loans Edition

Wednesday, April 16, 2014

When choosing a home loan, you’re generally given the option of borrowing that money on the condition of either a ‘fixed’ or ‘variable’ interest rate.

(What about split rate loans, you ask? They’re a happy alternative, and I’ve written about those too, but let’s not get ahead of ourselves just yet.)


So what’s the difference between fixed and variable?

If you choose a fixed rate of interest, your repayments will be the same throughout your fixed rate term. This is because with ‘fixed’ interest, your interest rate doesn’t change for the term at which you commit to it.

If you choose a variable rate of interest for your home loan instead, your repayments will change according to market fluctuations during your loan period. That is to say, your interest rate will increase or decrease according to what the market does.

To be clear, neither option is objectively superior to the other. They both have advantages and disadvantages. In choosing your home loan, you should simply examine which option best represents your values and priorities. If you value security, a fixed rate might be your best choice. If you value flexibility, a variable interest rate might be better.


What do I mean by flexibility and security?

A fixed rate home loan means you’ll have the same repayments for the length of your fixed rate term. Typically, banks and lenders allow you to fix your rates for five to ten years. If interest rates increase in that period, your repayments won’t be affected. Your rate will be secure. As such, you’ll be in a better position to plan longterm and factor in the annual costs of your home loan.

Hence, security.

A variable interest rate means your payments will fluctuate. If market interest rates dramatically decrease, your repayments will as well. They give you the flexibility to take advantage of the market, and not ‘lock you in’ so to speak, to the rates as they were when you acquired your home loan. Variable interest rate home loans can also include features like cashback and the ability to ‘offset’. These features enable you to withdraw repayments made in excess of your minimum repayment amount, and reduce the interest you pay using the money stored in your savings account (respectively.)

Hence, flexibility.

There are obvious disadvantages to both choices. In a fixed rate home loan, you can’t take advantage of lower market interest rates or vary your repayment schedule. In a variable interest rate home loan, you could end up paying more interest than what’s dictated by the interest rate your mortgage starts on.

Again, it comes back to your values and priorities. Every home loan and every borrower is different. Do you, future mortgage holder, prefer a flexible home loan agreement that will allow you to make early repayments and capitalise on market dips? Or do you, future mortage holder, prefer a secure home loan that will allow you to, by the numbers, plan for the future?

You may even want to combine fixed and variable interest rates into one of the aforementioned split home loans. It’s up to you.