Choosing between fixed and variable interest rates

What is the difference between a fixed and variable rate?

As the name suggests a fixed interest rate does not change for an agreed term.  Most lenders offer fixed rate periods anywhere between 1 and 5 years.  When the fixed rate period expires you may choose to rollover your loan for another fixed period or you can choose to move into a variable rate product.

The interest rate of a variable product will change from time to time.

What drives interest rates?

The Reserve Bank of Australia (RBA) sets official interest rates.  When the broader economy is doing well the RBA tend to increase interest rates.   Such a move makes borrowing less attractive.  When the economy is not doing so well the RBA will look to reduce interest rates to stimulate lending and spending.  Lenders are not compelled to reflect changes in the official interest rate however they typically pass on the rate cuts to remain competitive.

What is a good rate at present?

There are a number of factors that influence the interest rate of a loan.  Rates are generally lower on loans used to purchase a principal residence when compared to investment property loans. 

Where the borrower puts forward a small deposit the lender will generally increase the interest rate to reflect the increased risk to them.

Your personal circumstances will determine if you are eligible for a cheaper interest rate but there can be differences in rates offered between lenders.

Currently, you can access a variable rate home loan for as low as 2.19%, though many lenders fall between 2.50%-2.70% pa.

It is possible to get a fixed rate loan under 2.0% and most lenders offer rates under 2.50% pa.

Why are fixed interest rates so much lower than variable rates?

The disparity between fixed and variable interest rates reflects lenders belief that official interest rates will continue to fall.

Having lower interest rates on fixed products will entice borrowers to choose these products.  As interest rates drop the lender will benefit having locked borrowers to the higher fixed rate.

Whilst it might be hard to see further interest rate drops, lenders do not like to lose, and their research and pricing suggests there are further rate cuts to come.

Things to consider when going fixed or variable.

With a fixed rate loan, you often have limited capacity to make extra repayments and there are early exit fees if you wish to change the loan before the fixed term expires.

In addition, fixed rate products typically do not allow you to have an offset account (with limited exceptions by a handful of lenders).

Fixed rate products often have less fees because they do not offer more flexible features.  They can also provide certainty, making budgeting easier.

Variable rate products typically allow you to have unlimited additional repayments with redraw capacity as well as access to an offset account.  They do not have break costs therefore you are free to move between products and providers more easily.

These additional features often come at the expense of higher fees (in most instances) and if interest rates rise, you pay more.

Where to from here?

If you’d like to speak with one of our qualified mortgage experts, then feel free to give us a call on 1300 242 700.