Home loans 101: fixed rate home loans

Are you in the process of purchasing a property or land? One of the many important decisions you’ll have to make on your home buying journey is the type of home loan that will best suit your financial needs.

One home loan option you have is a fixed rate home loan.

This guide covers what a fixed rate home loan is, the potential benefits and drawbacks and the other home loans you can choose from.

What are home loan interest rates?

Home loan interest rates indicate how much interest you’ll have to pay for borrowing a certain amount of money from a lender.

How much interest you pay is calculated based on your interest rate, loan amount and loan term. In summary, interest rates are ultimately the cost of borrowing money.

Let’s take a look at an example. Let’s say you need to borrow $450,000 to buy a property in your preferred area.

You’ve decided on a loan term of 30 years and have locked in an interest rate of 1.99%. Your estimated monthly repayments would be $1,661 and you would pay $147,970 in interest over the life of your loan.

Keep in mind, these numbers are based on the borrowed amount, loan term and interest rate. They are subject to change if any of these factors or your home loan type changes.

Wondering how much your monthly repayments will be, or how much you might have to pay in interest over the life of your loan? Use our Mortgage Repayments Calculator to find out.

As your interest rate changes, so too will your repayments and interest on principal, unless you’re on a fixed rate home loan.

There are three different types of home loans to choose from – fixed, variable or split rate. Borrowers aren’t stuck with one over the life of their loan and can switch by refinancing.

What is a fixed rate home loan?

A fixed rate home loan is exactly as it sounds – an interest rate that doesn’t change. This means you lock into an interest rate, usually for a period of 1-5 years.

Your interest rate, and therefore monthly repayments, stay the same regardless of fluctuating interest rates for the fixed term period.

How do interest rate changes work?

The Reserve Bank of Australia (RBA) is responsible for setting the official cash rate (OCR) every month.

While the OCR can have a big influence on how banks and lenders set their interest rates, they are free to increase and decrease these rates independent of the OCR.

Why do interest rates fluctuate?

There are several reasons why interest rates fluctuate. These include:

• The RBA and OCR: the RBA’s goal is to support and strengthen the Australian economy and bases the OCR on this goal.
  
  Many banks and lenders use the OCR as a guide for setting their own interest rates. That way, they can provide interest rates that are feasible while still remaining competitive
  
  
• The strength of the economy: interest rates will typically mirror fluctuations in the Australian economy. When the economy is struggling, interest rates decrease to support recovery. Likewise, when the economy is strong, interest rates rise to encourage growth
  
  
• Changes to the cost of business: for profit purposes, some lenders may increase or decrease their interest rates to mirror the rising and falling costs of business
  
  
• To remain competitive: in order to remain competitive, lenders may also change their interest rates to be comparable with others on the market.

Keep in mind that on a fixed rate home loan, interest rate changes will not affect your monthly repayments during your fixed period.

What are the benefits of having a fixed rate home loan?

There are several reasons why you might want to sign up for a fixed rate home loan. These include:

• Consistent monthly repayments: interest rates are calculated daily and are subject to change. However, because you’ve locked in an interest rate for a fixed term, your monthly repayments will not change for that entire period
  
  
• Less financial stress and easier budgeting: your monthly repayments are guaranteed not to change during your fixed interest period. So, you won’t have to worry about fluctuating interest rates.
  
  This can make budgeting a breeze knowing you won’t have to reshuffle your finances due to rate changes. This can give you more peace of mind, financial stability and prevent financial stress
  
  
• No unexpected interest rate rises: even if the OCR and interest rates rise, you won’t be affected until the end of your fixed term. This way, you won’t be caught by surprise by fluctuating rates.

What are the drawbacks of having a fixed rate home loan?

All types of home loans will have their drawbacks. A few potential drawbacks with fixed rate home loans include:

• Limited extra repayments: fixed rate home loans typically limit the number of additional repayments you can make or forbid you from making any at all. If you make extra repayments against the terms and conditions set out by your lender, you could be subjected to a break fee.
  
  Break fees are charged because making extra repayments can lead to a financial loss for the lender. They recover this loss by charging it back to the borrower
  
  
• Don’t benefit from rate cuts: if interest rates decrease, you won’t be able to reap the benefits. This is because you’re locked into a specific rate for a fixed term
  
  
• Fewer home loan features: fixed rate home loans don’t offer as many features as variable rate home loans. Borrowers on a fixed rate home loan may not be able to use a redraw facility or link a 100% offset account to their loan over the fixed period
  
  
• Break fees if you refinance before your loan term ends: if you decide to refinance before the end of your fixed term, you will be charged a break fee.

Can you switch from a fixed rate to a variable rate or split rate home loan?

Yes, it is possible to refinance or switch from a fixed rate to a variable or split rate. However, doing so within your fixed term will incur a break fee. It’s also important to note that break costs are usually higher when interest rates drop.

Variable rate home loans are affected by fluctuating interest rates. That means if interest rates increase, so do your monthly repayments, and vice versa.

A split rate home loan (or a partially-fixed interest loan) allows you to access the features of both fixed and variable home loans by splitting your loan in two.

One portion of your split loan remains fixed and unaffected by fluctuating market changes while the other gives you the flexibility to make extra repayments and access features like an offset account. Keep in mind that the split doesn't have to be 50/50.

Do you have any questions about fixed rate home loans? Reach out to your local Aussie Broker to discuss which home loan rate is right for your financial situation and needs.

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