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If you’ve found yourself scratching your head trying to figure out all the different types of interest rates and how they affect your mortgage repayments, you’re not alone. With debates about whether you should go for a fixed or variable interest rate, and terms like split rate thrown in, it’s almost easier to just agree with whatever your lender tells you to take. However, knowing the difference between each interest rate type could mean saving heaps over the life of your loan.
In this article:
- Types of home loan interest rates
- What to think about when deciding
In the frenzy of buying their first home, people often overlook the terms and conditions of their home loan. For instance, their interest rate changes after the first year of their loan. Lenders attract buyers with low offers, highlighting how you might save in the first year. Nevertheless, without calculating the amount you pay in interest over time and comparing it to other interest rates on offer, you could be missing out. Couple this with certain features offered when you choose a select interest rate type and the amount of interest you pay could prove staggering in the long run. Not only could you accidentally prolong your loan term but you could also be paying more than you should be.
Here’s a breakdown of the differences between each rate and product type, and the benefits or drawbacks of each:
What is a fixed rate?
A fixed rate is when the interest rate you pay for a certain period of time becomes set (fixed) at the initial rate you and your lender agreed on. This period usually lasts for a few years. As such, even if market conditions or the Reserve Bank’s cash rate change, the interest you pay on your home loan will stay constant.
Thus, you will always know how much of your repayment is going towards paying for the principal amount of your home loan, and how much is going towards interest. While this protects you from sudden interest rate hikes, it also means you can’t take advantage of interest rate drops. This is because your lender may also charge you for making extra repayments. Furthermore, they will also prevent you from using features like an offset account. Generally, most lenders offer a lower fixed rate for the initial period of your loan. Usually, it’s about one to two years before switching back to a variable interest rate.
What is a variable rate?
A variable interest rate home loan means that you’ve been paying varying amounts of interest throughout your loan term. While you still make the same repayment amounts every month, the amount that goes towards interest and the amount that goes towards paying off your actual home differs every time the interest rate changes. While the rate you pay isn’t determined by market conditions explicitly, most lenders follow current conditions. This means that if the Reserve Bank of Australia lowers the cash rate, your interest rate might go down too. Since there is more fluctuations to your interest rates, your lender might offer you offset or redraw features. Additionally, they might even offer the ability to make extra repayments at no cost.
What is a split rate?
If you’re on a split loan, you’ll most likely reap the benefits of having both interest rate types simultaneously. How? Essentially, on a split rate loan, you’ll be paying a fixed rate on a portion of your loan, and a variable rate on the rest of it. While this means you’ll be subject to both the pros and cons of each rate type, you’ll also be getting the best of both worlds:
- Assurance that your repayments will definitely be going towards your home loan
- The ability to use the banking features that variable loans offer
Where to from here?
As always, choosing the right interest rate type for you depends on your current situation. Making the switch could mean the difference between spending thousands of dollars, or saving it.
Spend some time evaluating your needs and the options available to you. Alternatively, book a consultation here so we can guide you through the process!
Disclaimer: The information provided is general in nature and does not constitute financial advice. Please speak to us for recommendations on your individual circumstance and requirements.
