Deciding between a fixed and a variable interest rate, or a combination of both, is largely a personal choice. Do you need the certainty of set monthly repayments or are you looking for a little more flexibility and a saving when interest rates drop? Each option has its own set of pros and cons. Read on to find out what these are.
What is a fixed rate?
A fixed rate means the interest you pay remains constant for a set period of time. For example, you may have a fixed interest rate for a two-year period at 4.35 per cent. During that two-year period, you will pay a set amount against your mortgage charged at 4.35 per cent interest despite any interest rate movements in the market, either up or down. At the end of your fixed term, you can choose to take up a new deal with your lender or switch to a floating or variable interest rate.
Locking in your interest rate means you know exactly how much you’re required to pay towards your mortgage for the life of the term. This means you can budget the exact amount which makes financial planning that much easier. It’s also a way to safeguard against any potential increases in the interest rate over your fixed term and could mean you save should interest rates rise.
Of course, if interest rates drop, you don’t get the benefit of the decrease and your repayments will remain the same for the life of your fixed term.
What is a variable rate?
A variable interest rate means exactly that – the interest you’re charged varies, moving in line with the OCR (Official Cash Rate) set by the Reserve Bank, so any fluctuations in the market will be reflected in your mortgage repayments.
For example, at the start of your loan term, you may have agreed to pay an interest rate of 5.3 per cent. If interest rates go up, your lender will notify you of a change in your mortgage repayments and you’ll be charged the higher interest rate. Similarly, if interest rates drop, your rate drops too.
A variable interest rate offers you more flexibility. If rates go down, you can continue paying the same amount you’re already paying and shave years off your mortgage repayments. In most cases, you can also make lump sum repayments without penalty to further reduce your mortgage.
If interest rates rise, you’ll be charged a higher rate which can make planning your budget a little difficult.
There are a number of factors which will influence your decision when it comes to choosing between a fixed and a variable interest rate: Factors like your income and your ability to absorb a change to your repayments need to be considered.
Many borrowers find that splitting their loan and having a portion on a fixed rate and a portion on a variable rate offers an ideal solution. It’s best to get professional advice though before making any changes to your loan.
Talk to a Mortgage Express adviser and get advice about your home loan to ensure the option you choose is the best fit for your financial situation.
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