With all the financial decisions that need to be made when purchasing a home, choosing the options that make the best sense for you can seem overwhelming. Given the uncertainty of interest rates, deciding what type of mortgage to choose and from whom to borrow can be a difficult and time-consuming task. One of the most important decisions is what type of mortgage to choose. The choice between a fixed rate and variable rate mortgage can be an intimidating task if you are not armed with the facts, so here are a few things to consider before making a decision.
What Is Your Current Financial Situation?
One of the most important considerations to take into account before choosing a fixed rate or variable rate mortgage is knowing your current, short-term, and long-term financial outlook. If you are in a current financial situation in which your budget cannot handle the potential ups and downs of a variable rate, and a regular monthly payment makes more sense, then a fixed rate is probably a better choice.
What Is Your Long-Term Financial Outlook?
Another decision to make when selecting a loan is the amortisation period and the length of your current mortgage interest rate agreement. If your current financial outlook is very similar to your long-term financial outlook, then you may want to consider a longer term, variable rate loan. If, however, you are likely to have a considerable change or uncertainty in your income, retirement, or one income being lost, then choosing a shorter term, fixed rate may be the better choice.
Fixed Rate Home Loan
With a fixed rate mortgage your interest rate does not change for the agreed term of the loan. Lenders generally offer fixed terms from 1, 3 or 5 years, however some go up to 7 to 10 years. At the end of the fixed term, your loan will usually convert to a standard variable rate. Because it offers the borrower an assurance that both the principal and interest will remain the same throughout the term of the loan, a fixed rate mortgage is ideal for many.
- The interest rate will not change for the agreed fixed rate period. Should variable rates rise above your fixed rate, you will be happy to know you are paying less then what you could be paying with a variable rate
- You know exactly what your repayments will be, makes budgeting easier
- Extra loan repayments are often limited to small amounts if you have a fixed rate, or may only be allowed with a fee. Variable rate loans usually allow you to make extra repayments at no cost.
- Although currently there are some really low fixed rates available, they tend to be higher than variable rates
- Any interest rate decreases that might occur during the fixed rate term will not apply to your fixed loan.
- Fixed rate loans also usually have a break fee if you change or pay off your loan within the fixed term e.g. if you sell your home
Variable Rate Home Loan
With a variable interest rate home loan, your interest rate varies throughout the course of the loan. This means that your interest rate will likely both rise and fall multiple times during the lifetime of the loan.
- Your interest rate can be cheaper than a fixed rate loan at the time of application
- You will be able to make additional repayments into the loan, without any penalties
- Depending on the loan product, you can have an offset account attached to the home loan to further reduce the interest payable
- The amount of your regular repayments will fluctuate in line with any changes to interest rates.
- You have no protection against interest rate changes.
Why Not Have the Best of Both – Splitting Your Loan
This option is becoming more and more popular. It allows you to bet both ways and only fix part of your mortgage. Most people fix their loan at 50% to manage some of the risk of an interest rate rise whilst having the option of making extra repayments. Your financial outlook for the fixed period should help determine at what ratio to split your loan.
Regardless of your financial situation, it is always important to get the advice of a qualified mortgage broker, and ensure that you get your mortgage through an established and reputable lender.
Answering the following questions and discussing them with your broker will allow them to offer an appropriate solution to your situation:
- Do you anticipate any major changes to your family arrangements, your job or your business?
- Are you thinking of selling your property in the near future?
- Are you thinking of buying an investment property?
- Do you want the ability to make additional repayments?
- Do you want to be able to redraw funds from the home loan at some point in the future?
- Do you want to be able to use an offset account to reduce your overall interest charges?
- Do you want the security of your rate not changing?
- Do you want the certainty of knowing what your repayments are going to be?