Fixed vs. Variable Home Loan: How To Choose

If you’re in the market for a home loan in Australia, you’ll likely come across two options: fixed and variable home loans.

Why is it important? Choosing wisely between these could save you thousands of dollars.

This guide on variable vs. fixed interest rate home loans breaks down both options, explores the pros & cons, and helps you make an informed decision! Keep reading to figure out your best bet when choosing between these two.

Click on the highlighted text if you're looking for a comparison of the current home loan interest rates in Australia.

Fixed vs. Variable Home Loan: The Difference

There is a considerable difference between fixed and variable home loans. Essentially, it’s about the different rates of interest you pay over the life of the loan. Fixed-rate home loans in Australia come with a fixed interest rate while variable-rate home loans come with varying interest rates.

Let’s look closer at these two types of home loans…

Fixed Rate Home Loans

Here, borrowers can choose a time period, during which they are required to pay a fixed repayment amount calculated based on a fixed interest rate set by the lender. This interest rate is calculated at the time of locking in on your term, which is known as Rate Lock.

Although the entire tenure of the loan itself may span around 30 years, the fixed-rate period usually lasts only a portion of that time—usually between 1-10 years, depending on your lender. You can lock in on your fixed rate and its duration when you apply for the loan. And when this locked tenure of the fixed rate is coming to an end, you can submit a new Rate Lock application, if you wish to keep paying a fixed repayment amount.

However, each time you apply for a Rate Lock, the lender recalculates the interest rate, which may be higher or lower than your previous one.

Variable Rate Home Loans

With variable-rate home loans in Australia, the interest rate on your repayment amount keeps fluctuating. That means your minimum monthly repayment amount may increase or decrease, depending on the volatility of interest rates set by the bank.

These fluctuations are influenced by decisions made by the Reserve Bank of Australia, as well as other factors, which make your required interest payment unpredictable. 

Pros & Cons of Fixed Rate Home Loans

Having a fixed interest rate means your repayment amount is also fixed. Although it sounds like a better option, you must consider the advantages and disadvantages associated with it.

Pros:

• Potentially lower rates compared to variable loans, as repayments stay the same even if official interest rates increase.

• Stability in monthly payments.

• Peace of mind, knowing exactly what you’ll pay each month without worrying about rate rises.

• Easier budgeting.

Cons:

• Potentially higher rates than variable loans, as repayments won't decrease even if official interest rates drop.

• Limited flexibility, with restrictions on additional payments.

• Involves early payment or foreclosure penalties.

Pros & Cons of Variable Rate Home Loans

The major advantage of fixed-rate home loans in Australia is the fixed repayment amount. Variable-rate home loans offer the exact opposite: fluctuating payments. However, you could also be saving thousands of dollars on interest if the Reserve Bank of Australia and your lender adjust rates in your favour.

Pros:

• Lower minimum repayments when the official interest rate falls.

• Greater flexibility with no limits on additional payments. 

• No penalty charges on early repayments or foreclosure.

• Availability of redraws: when you make additional payments, some lenders will let you redraw these additional funds in the future.

Cons:

• Higher minimum repayments if the official interest rate rises.

• Unpredictable monthly payments due to fluctuating interest rates.

• Budgeting challenges since you cannot predict how the official interest rates might move.

Variable vs. Fixed Interest Rate Comparison

The interest rate on fixed and variable home loans is influenced by the lender, decisions from the Reserve Bank of Australia, and other factors. But in fixed-rate home loans, the interest rate is accurately predictable as your lender will directly communicate this with you at the time of Rate Lock. 

Fixed Home Loans Interest Rate Calculation

Let’s assume you took a $1 million home loan for a tenure of 30 years. And your lock-in period is 5 years at a fixed interest rate of 7% per annum. Then your total payable interest over 5 years would be:

$1,000,000 x 0.07 x 5 = $350,000

Variable Home Loans Interest Rate Calculation

Assume you took the same $1 million home loan for a 30-year tenure at an initial variable interest rate of 6% per annum, but the rate fluctuates over the 5-year period. The calculation for interest payment would look like this:

• Year 1: 6%

  •  $1,000,000 x 0.06 = $60,000

• Year 2: 6.5%

  • $1,000,000 x 0.065 = $65,000

• Year 3: 7%

  • $1,000,000 x 0.07 = $70,000

• Year 4: 6.8%

  • $1,000,000 x 0.068 = $68,000

• Year 5: 6.7%

  • $1,000,000 x 0.067 = $67,000

The total payable interest over 5 years would be $330,000.

Fixed vs. Variable Home Loan: Which One Should You Choose?

A fixed home loan is more advantageous when you want certainty in your repayments, protection from rising interest rates, and long-term financial stability, making it ideal for people who are into accurate budgeting.

On the other hand, a variable home loan is for people who are:

• Comfortable with fluctuating rates.

• Want to take advantage of potential rate drops.

• Want to take advantage of loan features like extra payments and redraws.

Ultimately, that means your decision should be based on your financial situation and risk tolerance. Our recommendation is to use an online mortgage broker who can help show you what option would be better for your unique financial situation.

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