Fixed rate home loan vs variable rate home loan

A fixed rate home loan that suits one person may not suit another person as well as a variable rate home loan might. It simply isn’t the case that one is better than the other. Each has pros and cons that may suit different goals and financial situations.

So, before you decide on a loan, read this guide full of information which may help you choose the type of home loan that’s suitable for you.

A fixed rate home loan is a home loan that has an unchanging interest rate (a fixed interest rate) for a specific length of time. The fixed term generally doesn’t cover the whole life of the loan, and typically lasts two to five years before reverting to the lender’s standard variable interest rate (unless you refinance).

A variable rate home loan is a home loan with an interest rate that may vary. Unlike with fixed rate home loans, the interest rate of a variable rate loan can change at any time, at the discretion of your lender.

As with all credit products, there’s no best option. Instead, there are a range of pros and cons to each that can make one or the other type of loan better suited to those in specific situations. These pros and cons may vary depending on the terms of the loan you choose.

Yes, you can generally switch your interest rate type even after you’ve signed your loan contract by refinancing. It’s possible to go from an entirely variable to a fixed rate loan, go from a fixed rate loan to an entirely variable home loan, and it may even be possible to split the loan.

This may not be possible with all lenders, however. And some lenders may charge fees for switching the rate internally or to refinance your loan with another lending institution if you find a better deal elsewhere.

Also, your new rate may not be the same as the rate would have been if you’d signed up with that kind of rate initially. As an example, if you signed up to a fixed home loan when the variable rate was 5 per cent and six months later you decide to switch to a variable rate, your new interest rate may not be 5 per cent, but could in fact be higher or lower.

If picking between a fixed or variable interest rate doesn’t feel quite right to you, there is actually an option to have a mix of both. A split rate home loan has different interest rate types for various portions of the loan. It applies a fixed rate of interest to part of the loan amount (for example, 50 per cent of the loan amount) for a specific period of time and applies a variable interest rate to the rest of the loan amount for the entire life of the loan.

When the fixed rate period is over, that portion of the loan usually then switches to the standard variable interest rate and could continue to vary for the rest of the loan term — unless you apply for another fixed term or refinance.

Split rate home loans offer several advantages and disadvantages depending on your circumstances.

Regardless of whether you decide to go with a fixed rate, variable rate or split rate home loan, the process of applying for a home loan is much the same.

The steps many borrowers will take to get into their new home can include:

• Use a borrowing power estimation tool to get an idea of how much you might be able to borrow. This will give you an indication of what housing price bracket you may be able to afford.
• Take a look at the homes that are available in the area you want to buy. Are there any in your price bracket? If so, you can move on to the next steps. If not, you may need to put together a plan for improving your borrowing power or choose a new area.
• At this point, you can dive right into house shopping, or you can apply for pre-approval. The advantage of conditional approval is that you’ll be able to more confidently submit an offer on a home, and you’ll be able to make your move more quickly, which could be invaluable if you're shopping in a competitive housing market (however, this is not a final approval or guarantee). This is a time you may want to do a comparison of a range of home loans, to see if you can find one that’s suitable for you.
• Choose a home that you can afford based on your pre-approval and borrowing power calculations. And check it meets your needs in terms of location, quality, size and features. At this point, it’s crucial you do a little maths to ensure you’ll be able to afford the non-loan costs that may be associated with buying any properties on your short list, such as stamp duty, conveyancer fees, building and pest inspection, removalist fees and more.
• Once you’ve found a home, submit an offer and negotiate with the vendor to arrive at a mutually agreeable price. Or, get yourself ready to bid at auction.
• Once a vendor has accepted your offer, or you win the home at auction, you can convert your pre-approval into a loan application. Or, if you didn’t get pre-approval, you can apply for your loan.
• You’ll then need to review all the loan documentation to ensure it meets your needs and that you’re happy with all the terms and conditions.
• Once you are approved and sign your loan contract, you can then exchange contracts on your new home, pay your deposit and set a settlement date. In most cases, your lender is likely to require you to get insurance on the home to start either from the time you exchange contracts or from settlement.
• Just before settlement, you’ll do a final inspection of the property. Then at settlement, your lender will pay the remainder of the agreed purchase price, your conveyancer will sort out various other pieces of documentation and you’ll get your keys.
• And then you can start moving in and enjoying your new home!