Should I consider a fixed-rate home loan?
See the pros and cons of a fixed-rate mortgage to see if it’s right for you.
One of the most regularly asked questions by borrowers is whether it’s a good idea to choose a fixed-rate home loan. A fixed-rate mortgage is one of the most common mortgage types in Australia, and it’s worth understanding the advantages and disadvantages of this kind of loan before making a decision.
What is a fixed-rate mortgage?
Fixed home loans have an interest rate that is fixed for a set period of time, this is usually for two, three or five years, with some lenders offering up to seven years. At the end of the fixed-rate term, the loan will usually switch to the standard variable rate offered by the lender.
The advantages of a fixed-rate mortgage
The main advantage of a fixed-rate mortgage loan is you know exactly how much monthly repayments will be over the agreed period, allowing you to budget more accurately over the term of the loan. And because the rate is fixed for a certain period of time, any interest rate increases won’t affect you.
The disadvantages of a fixed-rate mortgage
While fixed-rate home loans have some great benefits, they also tend to be inflexible, with a number of disadvantages.
It doesn’t come with an offset account
If you have extra money that could be used to pay back your loan, you won’t be able to put the money in an offset account and enjoy the interest repayment deduction.
Additional repayments are restricted
Most lenders will allow you to make some additional repayments to your loan during the agreed term, but it won’t be much, with the amount ranging from $20K - $30K over the course of the loan period.
For example, if you’ve agreed to a fixed-rate loan for two years, and your lender allows up to $20K in additional repayments, you can deposit another $20K on top of your normal monthly balance. This $20K can be made in one deposit or a few deposits over the two-year period. But you will not be allowed to deposit more than that, even if you have more.
Expensive break costs
If you pay back the loan before the fixed-term is finished, you could face expensive break costs. This often happens when the property has been sold or the loan has been refinanced.
The rate is fixed, even if rates drop
A fixed-rate mortgage loan locks you into an interest rate for a fixed term. So if the interest rate drops during your fixed loan period, you’ll still have to pay the higher fixed rate.
How much should I fix?
While there are positives and negatives to having a fixed-rate mortgage loan, the great news is you don’t have to fix the full amount of your loan — in fact, it’s quite common and good practice to choose a split loan structure.
In a split loan structure, you can have part of your loan fixed while and the other is variable. This allows you to get the best out of both types of home loans. How much you fix depends entirely on your maximum repayment in the fixed-term loan.
For example, your total home loan is $500K. You know that in the next two years, you can make a maximum $100K deposit into your loan. So the split loan structure should be $100K variable rate and $400K two-year fixed rate.
So, your goal is to repay the $100K in the next two years while the $400K will have a smaller, set monthly repayment amount that doesn’t go over the limit imposed by your lender. At the end of two years, your loan will be reduced by $100K, and depending on your financial situation, you can decide whether or not you should split the remainder of the loan again and set yourself another financial goal.
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