What is a variable rate home loan?

Before you decide whether a variable rate home loan is right for you, it’s important to understand what it is and how it works.

A variable rate home loan is a type of home loan with an interest rate that can fluctuate throughout the course of the loan term. This is in contrast to a fixed rate home loan, with which the interest rate is locked in for a set period of time.

Variable interest rate fluctuations are often influenced by the official cash rate set by the Reserve Bank of Australia (RBA). If the RBA increases the cash rate, lenders tend to increase their mortgage interest rates. Likewise, if the RBA cuts the cash rate, lenders will often pass this on to customers by lowering their mortgage interest rates.

However, it’s not unusual for lenders to introduce rate movements independent of the RBA’s decision. Of course, this can mean that at any stage of your home loan term, your mortgage repayments could get more or less expensive, which is something that’s important to plan for.

What are the benefits of variable rate home loans?

• They offer more flexibility – One of the key reasons many borrowers opt for a variable interest rate is because of the flexibility offered in comparison to a fixed rate mortgage. For example, variable rate home loans allow you to refinance whenever you see fit, whereas fixed rate home loans require you to wait until the end of the fixed period to do so – or else you’ll be hit with significant break fees.
• You could benefit from an interest rate drop – When mortgage interest rates go down, so will your repayments. This could allow you to put the savings towards another financial goal, or even use it to make extra repayments and pay down your mortgage faster.

What are the risks of variable rate home loans?

• You could be stung by an interest rate rise – In the instance that mortgage rates rise, so too will your repayments. That’s less money you’ve got to use elsewhere in your budget.
• Fluctuating repayment amounts could make budgeting difficult – You can’t be certain when your lender might increase your interest rate, so you’ll need to be prepared regardless. This could make budgeting for your overall expenses less manageable than a locked-in fixed rate loan.

Is a variable rate home loan right for you?

At the end of the day, the direction interest rates are likely to take over the short, medium and long term is very hard to predict. Moreover, it’s not hard to make an incorrect call – and even the best economists can get their rate predictions wrong.

That said, if you think that standard variable home loan rates are likely to fall, you might consider a variable rate mortgage.  Alternatively, if you think you will find it challenging to afford the repayments if standard variable home loan rates increase by 1 or 2 per cent, then a fixed rate mortgage could be a more manageable alternative.

Ultimately, the choice between a fixed and variable interest rate will depend on your personal financial situation, budgeting goals, and the amount of flexibility you prefer your home loan to offer.

To compare your options, check out RateCity’s variable rate home loan comparison table and fixed rate home loan comparison table.

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