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What’s the difference between fixed, variable and split rate loans?

An important factor to consider when choosing a home loan is whether to opt for variable or fixed interest rate loan. There’s also a third option to put into the mix – opting to go with both.

Variable rate loans

With a variable rate loan, the interest rate can go up or down with the market. That means if you have a variable rate loan, your repayment amounts will vary when the interest rate changes due to market changes. If interest rates go up, your repayments will rise as well; however if interest rates fall, your repayments will go down. This is the most common type of loan in Australia.

Variable rate features

  • Repayments go down when interest rates do
  • With most variable rate loans, you can make unlimited extra repayments, reducing the amount of interest payable and shortening the loan term
  • You may be able to add an offset account which can lower the interest paid on your loan
  • You may have the ability to redraw on your home loan to take out additional funds if the need arises. Redraw allows you to draw funds up to the difference between what you are required to have paid back and what you have actually paid.
  • You may be able to “top up” your home loan to access extra funds. A top up is where you apply to draw extra funds by increasing your borrowings on your property to make more available.

What about any possible downsides or a variable rate loan?

  • Repayments will go up if interest rates rise, which could have an impact on your household budget.

Fixed rate loans

With a fixed rate loan, the interest rate is fixed for a set amount of time – generally between one and five years. When the fixed period is over, you can either fix the loan again for a set amount of time at the rates available at the time, or let it automatically revert to the variable interest rate for that loan at the time.

Fixed rate benefits:

  • You’ll have the certainty of knowing exactly what your repayments will be during the fixed rate period
  • If interest rates rise your repayments will still stay the same, during the fixed period.

What about the possible downsides of a fixed rate loan?

  • You won’t get the benefit of lower repayments if interest rates fall during the fixed period
  • You’ll likely be limited by how much extra you can repay, during the fixed term
  • There will likely be costs if you want to end the loan before the fixed term is up. This is called “breaking your fixed loan”. These costs can be triggered by events such as refinancing, paying off your loan faster than your loan allows or selling without ‘porting’ the loan (you can usually take your loan with you even if the property securing it changes, such as when you move into another property). Your lender can explain what circumstances may constitute ‘breaking your fixed loan’.

What about split loans?

There is another option, one which combines the benefits of both variable and fixed, as well as their downsides. With a split loan (also known as a “combo loan”), you can fix one part of your loan and leave the rest of it variable. Going with a split loan could give you the best of both worlds – you’ll have the certainty of knowing what your repayments will be on the fixed portion while still having the potential to benefit from lower repayments should interest rates fall and all of the flexible features that a variable rate loan has.

The features of split loans:

  • There will be less variation in your repayments when interest rates change
  • If interest rates fall, your repayments on the variable portion of the loan will fall as well
  • You’ll have the option of making extra repayments on the variable portion
  • Variable rate loans often come with other features such as offset account that you’ll be able to take advantage of on the variable portion as well.

What about the possible downsides of split loans?

  • If interest rates rise, your repayments on the variable portion will rise as well
  • Your ability to make extra repayments will be largely limited to the variable portion of the loan.
  • There will be costs involved if you exit the fixed portion early.

Learn more about split loans