Which interest rate type should I choose?
When applying for a mortgage you will need to decide on an interest rate option. Fixed and variable interest rates are the two primary options available with each having distinct characteristics and financial implications. Understanding these differences can help you to make informed decisions based on your financial goals and risk tolerance.
Fixed interest rate mortgages
A fixed rate remains constant for a pre-determined period, typically 1-5 years. During this time repayments remain unchanged regardless of market fluctuations.
Advantages
Predictability: repayments are locked in offering certainty for budgeting and financial planning
Protection against interest rate hikes: borrowers avoid increased repayments if interest rates rise
Stability: ideal for those prioritising medium term certainty over flexibility
Disadvantages
No benefit from rate decreases: if interest rates fall borrowers remain locked into their original rate for the period that they agreed to
Limited flexibility: extra repayments may incur fees or be restricted and redraw is often unavailable
Break costs: exiting the loan early for any reason may trigger substantial financial penalties
Variable interest rate mortgages
Variable rates fluctuate based on market conditions, often tied to the Reserve Bank of Australia’s (RBA) cash rate. Repayments increase or decrease as lenders adjust rates
Advantages
Flexibility: borrowers can make unlimited extra repayments, often without fees, reducing interest costs and loan terms
Rate reductions: lower repayments if market rates decline
Redraw access: funds from additional repayments can often be redrawn as needed, making this loan a great option for putting savings to work
Disadvantages
Rate risk: rising interest rates increase repayments, potentially straining budgets. Banks may increase interest rates independently of the RBA.
Budget uncertainty: fluctuating repayments can complicate medium and long term financial planning
Exposure to market volatility: economic shifts directly impact repayment amounts
Key considerations when choosing which type of interest rate is best for your mortgage
Split loans: depending on your circumstances, you might consider splitting your loan so that part is fixed and part is variable. This option offers a degree of certainty (fixed portion) whilst offering full flexibility for part of the loan (variable portion)
Market trends: fixed rates may suit low rate environments, whereas variable rates align with expectations of rate cuts. Beware though, this can be very difficult to predict (even for the experts!)
Financial goals: fixed rates benefit risk-averse borrowers or those borrowing at the top end of their budget, whereas variable rates suit those who prioritise flexibility and are able to manage increased repayments should interest rates incraese
At the end of the day there is no one size fits all. Choosing between fixed, variable or mixed hinges on many factors, such as individual circumstances, risk tolerance, cash flow stability and market outlook. Borrowers should weigh short term flexibility against mid-long term predictability and select the optimal structure for their needs.
Please speak to your broker about this very important choice. They will be able to help you understand the T&C’s of each option and model out the different costs involved specific to your situation.