The interest rate on a home loan is important because it affects how much your monthly mortgage repayments will be, as well as the total amount you will pay before you own your home outright.
Many Australians took out fixed home loans when rates were at a record low in 2020 and 2021. Since April 2022, the RBA has raised interest rates 11 times in a row. With the fixed rate term about to end for an estimated 800,000 mortgage holders, many people are wondering how to avoid significantly higher monthly repayments.
Instead of moving across to a variable rate, some people choose to refinance: either with a new lender or a better deal with their current lender. Eligibility requirements apply, however, and many Australians may find they do not meet the new lender’s serviceability criteria.
It’s concerns like these that make first home buyers unsure whether to choose a fixed or variable home loan. There are advantages and disadvantages to each, so it is important to select the option that best suits your circumstances.
Avoiding a situation known as mortgage stress, when a third or more of your income is going to repayments, is important for long-term wellbeing.
What Is A Fixed Rate Home Loan?
A fixed-rate home loan means that the interest rate does not fluctuate during a stipulated period, which is usually between three and five years.
Fixed rate home loans protect the mortgagor from any sudden increases in interest rates by the RBA. These interest rate increases have been frequent lately, because the central bank has been attempting to curbinflation.
By contrast, a variable rate home loan is when the interest rate changes in line with market conditions and the cash rate set by the Reserve Bank of Australia (RBA). Payments will different each month–as interest rates rise, so too do repayments.
Pros of Having A Fixed Rate
The main advantage of a fixed-rate home loan is the financial certainty it can provide. The interest that you pay on your mortgage will not change for a stipulated period, which is usually between three and five years.
Even if your lender increases their interest rates, your repayments will remain the same. First home owners who are getting used to making regular repayments may find this much less stressful.
Some fixed rate products will also allow a limited amount of additional repayments to be made without incurring a penalty, but if you plan to make additional repayments to your fixed rate loan, it is important to understand what this limit is first.
Cons of Having A Fixed Rate
The certainty a fixed home loan provides makes budgeting much simpler, but there are some downsides too.
The main disadvantage is not being able to respond to changing financial conditions. When interest rates are going down, it can be frustrating to know that a variable rate mortgage would see you paying less each month.
If you unknowingly repay too much one month, there can be a financial penalty.
Fixed-rate mortgages typically do not offer features such as an offset sub-account, which is a linked account that can be used against the balance of your loan and reduces the amount of monthly interest.
Another downside is that if you sell your home within the term of the mortgage, you may incur expensive break fees.
What is the mortgage cliff?
A ‘mortgage cliff’ is when a fixed interest rateswitches to a highervariable rate and the payments become much higher than they were previously. This can be avoided by refinancing with a new lender or with a different loan to get a better deal.
In 2023, around 800,000 home loans totalling $350 billion will fall off a mortgage cliff, according toestimatesfrom the Reserve Bank of Australia (RBA).
What to Consider Before Fixing a Home Loan Rate
Trying to decide which way to go can be stressful, because the wrong decision could result in thousands of dollars in extra repayments being made.
However, the general advice is that first home buyers should choose a fixed-rate loan because it is far easier to budget and stay on top of repayments–which is the most important thing.
Once the fixed term is up, you may decide that you are comfortable switching to a variable rate.
How Long Should I Fix a Home Loan For?
A fixed rate term can last between one and five years. The most common period is between three and five years.
There is little point in fixing a loan for two years or less because it is too short a timeframe to protect yourself from interest rate hikes.
Locking in an interest rate for more than five years is also inadvisable, as it is too restrictive. While locking in your rate for a longer period will likely get you a better deal, it becomes more difficult to anticipate what will happen to interest rates several years from now.
ANZ and RAMS are the only major lenders in Australia that offer 10-year fixed-rate mortgages. Long-term fixed rate mortgages of 20 or even 30 years have been popular in the United States since the Global Financial Crisis of 2008 caused a housing crisis.
Most people choose a timeframe based on what they believe will happen to interest rates in the short and medium term.
Is It Worth Fixing A Home Loan?
Fixing a home loan there are expectations of further rate rises is less advisable. After 11 consecutive rate rises, Australia may have reached a peak. Nothing is certain however–prior to the last rate rise, economists were divided as to whether the RBA would pause interest rates.
Alternatives to Fixed Rate Home Loans
There are three kinds of home loans in Australia: a fixed rate mortgage, a variable rate mortgage and a split loan.
A fixed-rate home loan means that the interest rate does not fluctuate during the fixed rate term of the loan.
A variable rate home loan is when the interest rate changes in line with market conditions and the cash rate set by the Reserve Bank of Australia (RBA).
A split loan is also known as a ‘partly fixed loan.’ Part of the loan has a fixed interest rate and the other part is variable.
You can use our mortgage calculator to consider what your repayments would be.
Frequently Asked Questions (FAQs)
Do most Australians have fixed rate home loans?
A minority of Australian borrowers take out fixed-rate mortgages, and almost all fixed-rate mortgages do not exceed a period of 1 to 5 years.
First home buyers who are not accustomed to making regular repayments may find that an initial fixed term mortgage is beneficial, as it provides certainty as to how much repayments will be.
How can I calculate my mortgage repayments?
Before taking out a mortgage, it is essential to calculate what your monthly repayments would be to ensure you can afford the loan. Our Forbes Advisor mortgage calculator can help you determine what your monthly repayments may be under different interest rates.
What is the current fixed rate for mortgages?
In Australia, there isn’t a centralised fixed rate for home loans. Instead, banks and lenders provide their own rates and terms depending on their offerings and your needs.
Should I fix my interest rate in 2023?
Whether or not to fix your interest rate is a personal decision, which comes down to the factors Forbes Advisor explored within the above article. Economists believe interest rates will decline in the foreseeable future, but these are solely predictions. No one knows how the economy will be affected in the coming years.