Fixed vs Variable Interest Rates: Making the Right Choice

One of the most significant decisions Australian home loan borrowers face is choosing between a fixed or variable interest rate. Each option comes with distinct advantages and disadvantages, and the right choice depends on your personal circumstances, risk tolerance, and financial goals. This guide examines both options in depth to help you make an informed decision for your home loan.

Understanding Variable Rate Home Loans

A variable rate home loan has an interest rate that can change over time based on market conditions and the lender's discretion. When the Reserve Bank of Australia adjusts the cash rate, variable rates typically move in the same direction, though lenders are not obligated to pass on the full change. Variable rates have historically been the most common type of home loan in Australia, offering a combination of flexibility and the potential to benefit from rate decreases.

Advantages of Variable Rates

The primary benefits of variable rate home loans include the ability to make unlimited extra repayments without penalty, helping you pay off your loan faster and save on interest. Variable loans often come with offset account facilities that can significantly reduce your interest costs. If interest rates fall, your repayments will decrease, providing immediate relief to your budget. Variable loans typically have more flexible features and fewer restrictions compared to fixed rate products. You can also refinance or pay out your loan at any time without incurring break costs.

Disadvantages of Variable Rates

The main drawback is uncertainty. If interest rates rise, your repayments will increase, potentially straining your budget if you have borrowed close to your maximum capacity. This uncertainty can make financial planning and budgeting more challenging, particularly for first-time borrowers who may be adjusting to the costs of home ownership. There is also the psychological factor of potentially watching rates climb while feeling locked into a loan at a higher rate.

Understanding Fixed Rate Home Loans

A fixed rate home loan locks in your interest rate for a set period, typically between one and five years. Regardless of what happens to market rates during this period, your repayments remain constant, providing certainty and protection against rate increases. At the end of the fixed term, you can choose to refix at prevailing rates or switch to a variable rate.

Advantages of Fixed Rates

The certainty of knowing exactly what your repayments will be makes budgeting straightforward and provides peace of mind. If you fix at the right time and rates rise, you are protected from increased costs for the duration of your fixed term. Fixed rates can be particularly valuable for borrowers on tight budgets who cannot afford payment increases, or for those who prefer the psychological comfort of knowing their largest expense is locked in.

Disadvantages of Fixed Rates

If market rates fall after you fix, you will not benefit from lower repayments and may end up paying more than variable rate borrowers. Fixed rate loans typically have restrictions on extra repayments, often capping additional payments at $10,000 to $30,000 per year, limiting your ability to pay off the loan faster. Most fixed loans do not offer offset accounts, or if they do, the offset may be partial rather than full. Perhaps most significantly, exiting a fixed loan early incurs break costs that can run into thousands or even tens of thousands of dollars, making it expensive to refinance or sell your property during the fixed period.

The Split Loan Option

Many Australian borrowers choose a middle ground by splitting their loan between fixed and variable portions. This approach provides some certainty from the fixed portion while maintaining flexibility with the variable portion. For example, you might fix 60 percent of your loan for three years while keeping 40 percent variable, allowing you to make extra repayments into the variable portion while having budget certainty on the bulk of your loan.

Split loans are particularly popular when borrowers are uncertain about the direction of interest rates or want to hedge their bets. The split ratio can be customised based on your priorities, with those valuing certainty splitting more toward fixed and those prioritising flexibility keeping a larger variable component.

Factors to Consider When Choosing

Your Risk Tolerance

How would you feel if your repayments increased by $500 per month? If this would cause significant financial stress or anxiety, a fixed rate may provide valuable peace of mind. If you have buffer in your budget and are comfortable with some variability, a variable rate offers benefits that may outweigh the uncertainty.

Interest Rate Outlook

While nobody can perfectly predict future rates, considering the economic environment is worthwhile. If rates are at historically low levels, fixing can lock in these low rates. If rates have been rising and are expected to plateau or fall, variable may be more attractive. Keep in mind that fixed rates are priced based on market expectations, so if everyone expects rates to rise, fixed rates will already be higher than variable rates to account for this.

Your Financial Goals

If paying off your mortgage quickly is a priority and you plan to make significant extra repayments, a variable loan is usually better suited due to its flexibility. If budgeting certainty is more important and you are content to make minimum repayments, fixed rates work well. Consider where you see yourself in five years and choose accordingly.

Property Plans

If there is any chance you might sell your property or need to refinance within the next few years, be cautious about fixing. Break costs can be substantial and may eliminate any savings from a lower fixed rate. Variable loans provide the flexibility to exit without penalty.

Making Your Decision

Feature	Variable Rate	Fixed Rate
Rate Movement Risk	Yes - rates can go up or down	No - locked for fixed period
Extra Repayments	Usually unlimited	Often capped or restricted
Offset Account	Usually available (100%)	Rarely available or partial
Early Exit Costs	None or minimal	Potentially substantial
Budget Certainty	Lower	Higher

Conclusion

The choice between fixed and variable rates is personal and depends on your unique circumstances, risk tolerance, and financial goals. There is no universally correct answer, and what works for one borrower may not suit another. Many Australians find that a split loan offers the best of both worlds, providing some certainty while maintaining flexibility.

Whatever you decide, make sure you fully understand the features and restrictions of your loan before committing. Consider speaking with a mortgage broker who can help you compare options across multiple lenders and explain the implications of each choice for your specific situation. And remember, if you do fix and circumstances change, the break costs may be worth paying if refinancing to a better product provides long-term benefits that outweigh this one-time expense.