What is a variable rate home loan?
What is a variable rate home loan?
A variable rate home loan has an interest rate which can fluctuate as your lender responds to economic factors such as the cost of funding, the Reserve Bank of Australia’s official cash rate decisions each month and more.
This means over the course of a year, your home loan rate (and your periodic repayments) might increase or decrease. In Australian history, variable interest rates have seen highs of around 17%, and lows around 3%.
Variable rate home loans contrast with fixed rate home loans, where you enter into an agreement with your lender for a predetermined period of time, usually between one to five years, during which your interest rate won’t change.
There are also mixtures of variable rate and fixed rate home loans known as split rate loans, and these allow you to split your home loan into two or more portions and allocate variable or fixed rates to each portion.
Pros and cons of a variable rate home loan
In general, variable rate home loans have advantages and disadvantages you should be aware of.
Pros
- Features. Many variable rate home loans come with useful features, such as the ability to make additional repayments, offset accounts and redraw facilities. These features are not offered in abundance with fixed-rate loans.
- Easy to refinance. When you opt for a variable rate loan, you have the flexibility to refinance with another lender in order to secure a more competitive deal. With a fixed rate product, however, you would need to pay high discharge fees to exit the loan early.
- Falling interest rates. A variable rate home loan provides you with the ability to benefit from falling interest rates, which are typically passed on to variable rate customers. Even a 0.25% rate reduction could make a big difference to your periodic repayments.
Cons
- Interest rate rise. An interest rate rise on a variable rate home loan would make your repayments more expensive, and could make it more difficult to service your loan.
- Difficult to budget. If your rate is fluctuating regularly, it can be difficult to plan an accurate budget. You might have less money to allocate to other expenses if your home loan repayment rises.
How do you compare variable rate loans?
Comparing a variable rate home loan should take into account a range of factors, including:
- Interest rate. Interest rates will impact your repayments, so ensure you choose an interest rate which will result in a repayment you can manage. It’s also a good idea to use a repayment calculator to find out what your repayments will look like with the given interest rate, and also add an extra 1% on top of this to see what your repayments would be should interest rates rise. This will help you prepare and manage your interest rate risk.
- Fees. A variable rate home loan can come with a range of fees, including upfront application fees or ongoing fees, as well as fees to use features including offset accounts or redraw facilities. Ensure that the fees justify the interest rate and features you’ll receive with the loan. This is why you should always pay attention to a loan’s comparison rate, which takes into account its interest rate and fees and expresses them as a percentage.
- Features. What features you choose to add to your comparison will depend on how you want to use your home loan. If you prefer to have your salary paid into your home loan to minimise your interest charged, you might want to look for an offset account. If you want a home loan that allows you to make unlimited additional repayments, you might want to look for home loans with a free redraw facility.
- Eligibility. Different lenders will put limitations on what types of properties they will finance and the types of borrowers they will accept. Ensure the loans you’re comparing are available for your situation, including the type and size of the property, your income source and your loan purpose.