Buying a home is an exciting time, and it can be easy to overlook some of the critical features of finding the right loan. One of the biggest decisions to make when getting a new home loan or mortgage is whether to go with a fixed interest rate or variable interest rate mortgage.

When you compare home loans you need to consider your personal circumstances such as lifestyle, budget, cash flow, financial situation, and your contingency plans. Some loans offer flexibility, whilst others provide you with the certainty of a known repayment amount for a period of time. Finding the right home loan can save you thousands on repayments throughout the life of the loan.

What is a fixed interest rate?

A fixed rate home loan is a set interest rate for the fixed term (the agreed time is usually 3 years but can vary depending on the loan provider and what you negotiate). The key feature of the fixed rate is that it does not change during this agreed period, no matter how much interest rates rise or fall.

Advantages of a fixed interest rate

When interest rates rise, the rate does not fluctuate for the agreed period. A fixed rate loan offers peace of mind because you know the repayment will not change until the agreed period has finished. After the fixed rate period, the loan may switch to a variable interest rate unless you make other arrangements with your financial institution.

Many borrowers like fixed rate home loans because it can help with budgeting when you know exactly what your mortgage repayment will be each week, fortnight or month, depending on your repayment schedule.

Disadvantages of a fixed interest rate

When rates fall and stay lower than your locked fixed interest rate you can get stuck paying higher interest than if you were on a variable rate loan.

Ending a fixed rate loan during the fixed term may incur expensive break costs. The formula for calculating a break cost is included in your fixed rate loan contract.

You may also be limited in your ability to make additional payments above your contractual loan repayments. Some institutions do not offer an offset account with a fixed rate loan. These limitations can reduce your ability to pay off your loan sooner.

Northern Inland Credit Union offers an offset account with a fixed rate home loan.

What is a variable interest rate home loan?

Variable interest rate loans tend to reflect movements in the Reserve Bank cash reference rate. You need to ensure you have a plan of what to do if interest rates rise. A rise in interest rates will often result in an increase in the amount of your scheduled loan repayments, in order to keep your loan within its term.

Advantages of a variable interest rate home loan

Variable rate loans provide far more flexibility than a fixed rate loan. The biggest benefit of variable rate loan is that you do not miss out or 'get stuck' on a higher interest rate when interest rates fall. Additionally, you can usually make unlimited extra repayments, giving you the ability to pay the loan faster. Many financial institutions offer a free redraw facility, so you can draw back on extra amounts you have paid into your loan, above what is required by your normal scheduled repayments, should you need to cover an unexpected cost.

Offset Accounts

An offset account operates similarly to a standard bank account, with the difference being that it is linked to your mortgage.

Whilst your offset account is not interest-bearing, its balance offsets the balance you owe on your loan, and operates to reduce the interest that is payable on your loan. Check the terms and conditions that apply to your offset account; some institutions only offer offset accounts that apply a percentage of your offset balance against your loan balance. At Northern Inland, 100% of the offset balance as at the close of business is offset against your loan balance, for the calculation of loan interest.

An offset account balance reduces the amount of interest you will pay on your mortgage over time. For instance, at Northern Inland where 100% of your offset balance applies to offset your loan balance, if you have a loan of $700,000 and maintain a balance of $50,000 in your account, you will only be charged interest on $650,000 for that day.

Northern Inland offers offset accounts for a number of variable and fixed rate home loans. At Northern Inland, you can elect to have a number of offset accounts linked to your home loan account, to help with your household budgeting.

Lump sum home loan repayments

Making additional payments or lump sum payments to your mortgage reduce both the interest and principal components of your loan, helping to you to pay off your loan faster.

Generally variable rate loans will allow additional repayments on top of your regular monthly repayments. Fixed rate loans may limit the amount of extra repayments you can make. At Northern Inland, extra repayments of up to $10,000 in any one year is permitted to your fixed rate home loan.

Disadvantages of a variable rate home loans

Between May 2022 and August 2023, the Reserve Bank of Australia raised the cash reference rate 12 times from 0.1 per cent to 4.1 per cent. If you had a variable rate loan during this period, you would have seen your loan repayments increase. Borrowers on a fixed rate home loan would have locked in a lower rate for the fixed period. If you do not have much wriggle room in your budget a variable rate loan can be riskier, but you also need to bear in mind that a fixed rate is generally higher than a variable rate, and you can only fix your rate for a limited period of time.

What is a split rate home loan?

Splitting your mortgage to be partly fixed and partly variable is also an option for borrowers to reduce the associated risks with variable rate loans and fixed rate loans.

A split rate mortgage limits the potential advantages of a fixed interest and the potential advantages of a variable rate loan. However, splitting your home loan is a less risky option for those worried about being on the wrong type of loan at the wrong time. In practice, it involves having two home loans – one with a fixed rate, and one with a variable rate. At Northern Inland, both such accounts can have offset accounts attached. Whilst your repayments to both loans can be automated, borrowers need to consider where to place any spare savings in order to maximise the advantages of the arrangement.

Is it better to have a fixed or variable?

Choosing a home loan depends on your personal circumstances, and what you are seeking from your home loan. Matters to consider are:

  • Are you likely to want to make extra payments to your home loan over time?
  • Is certainty of repayments important to you?
  • Is flexibility important to you?

See the Target Market Determinations for the loan account you are considering.
Other factors to consider are:

  • Availability of offset accounts
  • Availability of a redraw facility
  • Any applicable fees. You need to consider whether the costs of moving an existing home loan outweigh the benefits of maintaining your existing home loan.

It is vital that you reassess your home loan regularly to ensure you are making the most of the facilities available to you.

This article is general in nature and does not constitute personal advice. Consider your circumstances and read terms and conditions before making a decision on whether a product suits your needs.

Speak with a Northern Inland home Lending Specialist about your needs today, enquire online now.