Generally, when you take out a home loan, you have options to choose: a fixed interest rate or a variable interest rate.
Fixed home loans have an interest rate that is fixed for a set period of time, typically 1, 3 or 5 years. At the end of the fixed-rate term, the loan will usually switch to the standard variable rate offered by the lender. The main advantages of fixing rate are rate increase would not affect your monthly repayment and it is easier to manage your budget and set up financial goals as the repayment is a certain amount.
But some drawbacks with fixing your loan are:
- You won’t benefit from a drop in interest rate if the variable rate is lower than your fixed rate.
- Most banks will set a limit on extra repayment amount you can make.
- A redraw facility may not be offered on a fixed-rate loan.
- Break fees – when you change or pay off your loan within the fixed-rate period
Variable-rate, in contrast, gives you some flexibilities when you change financial plans or so. Some main advantages of variable home loan:
- You can make extra repayment as much as you want at no extra cost, which can save you interest and you can pay off the loan sooner
- More features: redraw facility, an offset account
- More flexible: you can easily switch loans to other product or lenders when you find a much better deal elsewhere
However, disadvantages of variable loan should consider are the facts it is harder to make budgeting as the rate can increase and you may struggle with repayment increase unpredictable.
Can’t decide? A splitting loan is a good compromise
Another option you may think of is having a part fixed and another variable interest loan. The split loan allows you to not only to minimize the risk of an interest rate increase but also give you more flexibility to make extra repayments. And you can choose how to split the loan, i.e 50/50 or 30/70. By doing this, you can both manage to budget and have benefited from features like redraw, offset account and reduce the break fees when you change your financial plan.