Fixed, variable or split loans: what works best for you
Fixed, variable or split loans: what works best for you? There are pros and cons of each. We'll take you through each option.
If your calculator has recently become your best friend, come join the party of budget battlers, particularly those in the mortgage war zone.
With the Reserve Bank of Australia (RBA) now hiking interest rates upwards and expected to do so for the short-term future at least, mortgage holders are now wondering which loan is the best to fly with.
Fixed, variable or split loans...let's look at the pros and cons of each.
Fixed-rate loans
We talked about these loans previously so we suggest you look at this article for more information on them.
But here are some key details to emphasise about fixed-rate loans.
At a time of jumping interest rates, fixed-rate loans can seem like the best way to go, protecting mortgage holders from rapidly changing figures - and they can be fantastic.
They're a good choice for risk-averse mortgage holders who prefer financial stability and a budget that won't rise and fall with the RBA's monthly cash rate announcements.
But there's more to the story than this.
Interest rates may drop during the period of your fixed-rate loan so you'll miss out on this choice benefit.
This is the main reason that mortgage holders shy away from these loans and long-term ones in particular.
Don't be fooled by the "fixed" description
Every lender, from the small-scale lenders to the Big 4 banks, increases their interest rates for longer fixed-rate loans.
The interest you'll pay for a one-year fixed-rate loan can be almost 1% lower than that of a five-year fixed-rate loan.
The good news is that you can cut and run from a fixed-rate loan - also known as refinancing - when it expires.
Alternatively, you can start over again with another fixed-rate loan with the same lender at this time.
But those who choose to begin again with their fixed-rate loan for another period will find themselves paying an updated rate, that reflects the current cash rates.
This change could be quite surprising - if not to say nasty - if you're locked into a five-year fixed rate only to start over and find the market has changed considerably in that time.
Expect interest rates for five-year fixed-rate loans to be between 2.97%-4.84%.
These fixed rates were actually spiking well before the national cash rate increase began last month; in fact, they've double in the past year alone, AMP Capital chief economist Dr Shane Oliver recently explained.
So, expect them to hike even higher as interest rates rise in the near future.
Fixed-rate loans usually don't come with benefits such as offset accounts and redraw facilities, plus it's harder to pay off your loan earlier or even make larger repayments thanks to high "break" fees.
Variable home loans
Many people have now enjoyed variable home loans for so long, particularly in the past few years of record low interest rates, that switching to a fixed loan can be a major question mark.
Saying this, you don't need to necessarily switch to a fixed rate if you feel the pros of variable loans outweigh the cons.
Here's what to consider with variable home loans.
Variable loans were a great idea for mortgage-holders during the past decade as interest rates were decreasing - or at least remaining at a steady low point of 1.5% - throughout much of the 2010s.
Variable loan mortgage holders thus benefited from these low rates rather than remaining at the mercy of the higher rates we are now experiencing.
Saying this, variable loans can offer far lower rates than their fixed-rate cousins.
Lenders are offering variable rates of between 2.46%-3.05% and while these rates will probably increase with spiking interest rates, they're still very attractive when compared to those of a fixed-rate loan.
Another great benefit of variable loans is their fantastic flexibility.
Think extra repayments with no nasty fees involved, benefits such as offset accounts and redraw facilities, and depending on your lender, the possibility to flex your financial muscles with loan agreement alterations and changes.
There is still plenty of general misgiving about when and by how much the RBA will change the cash rate.
Even industry experts aren't certain about these points so it may well pay to stick with your variable loan.
Split loans
Enter: the (possibly) perfect loan compromise.
Also known as partially-fixed interest loans or combination loan structures, split loans allow mortgage holders to enjoy the best of both loan worlds: the stability of a fixed rate combined with the flexibility of a variable rate.
It's important to note that you'll still be applying for just one home loan but with the split of variable and fixed set beneath a single loan umbrella.
Sounds good, doesn't it?
But everything isn't exactly what it seems even in a perfect split world so let's reflect on these points.
You can choose what part of your loan you'd like in your variable and fixed corners, such as a 20% variable component and an 80% fixed component.
In this particular case, 80% of your loan won't be affected by interest rate hikes but the opposite is also true if rates drop.
Then again, your entire loan won't have to go into damage control if a rate cut occurs - just 80% of it will.
In the meantime, your 20% variable component is working hard to enjoy potentially lower rates either way than its fixed neighbour and especially so if rates drop.
As well, benefits such as extra repayments and offset accounts can really benefit your variable component - but can't be done in your fixed sector.
You will probably find yourself paying two very different interest rates within your one split loan, particularly in today's rapidly changing market.
As a result, organising your budget can be more difficult compared to a 100% variable or fixed loan.
You're always partially protected while being perpetually at a disadvantage, especially when it comes to interest rate rises and falls.
So the RBA's monthly cash rate announcement will still be a day of both dread and comfortability.
Can you live with this half-and-half home loan life?
Only you can answer that.
