When it comes to home loans, there are many decisions to be made. What size loan to apply for? What LVR to use? What interest rate repayment style to use?
The choice between fixed interest rates and variable interest rates is one of the key points that buyers need to decide on, but how does a buyer make the choice to suits their needs? Let’s look at the type of home loans available to buyers.
Fixed home loan
A fixed home loan is where the interest rate is agreed and cannot move for an agreed period. Many lenders will let you fix your interest rate for anywhere between one and five years. The benefit of fixing a rate is the certainty it provides, particularly if you know you can afford the monthly repayments at the rate you have agreed. The downside is that if interest rates fall lower, you will miss the benefit of this.
Variable home loan
A variable home loan rate means the interest rate changes and can move up or down. This means a loan can become more expensive if interest rates go up, but more affordable if interest rates fall. With a variable home loan, there is often no limit on additional payments, meaning you have the choice to pay down the loan faster if it suits you. Offset accounts, which allow you to keep your spare cash sitting in the loan and reduce your monthly repayments are also usually associated with variable home loans and not with fixed rate home loans.
Split home loan
You guessed it! A split home loan is a combination of a fixed home loan and a variable home loan. Once the fixed home loan component period ends, it reverts to a variable home loan.
What are the advantages of a split home loan?
By being able to repay the variable component of the split home loan early, it may suit some to have part of a home loan variable interest to be able to take advantage of improved cashflow. Perhaps you are expecting a windfall from selling another asset, an inheritance, or maybe you will receive a bonus from work. Any of these amounts can be used to pay down the variable part of the loan.
Another possible advantage of a split home loan is by keeping some of the loan fixed, you are protecting yourself from the possibility that interest rates start to increase, as part of the loan will have a fixed monthly repayment attached.
Possible risks of taking a split home loan
One possible risk with the fixed part of the home loan is that there are likely to be additional costs if you repay this earlier than the fixed rate term. For example, if you sell the property soon after buying it, you may need to pay penalties associated with ending the fixed component of the loan early. If you are expecting to flip a property, a split loan or a fixed loan may not be suitable for you.
Another possible downside is you may not have the choice to have an offset account. This means the interest you could save by having extra funds sitting in the loan account may not be possible with this loan type.
The moral of the story
Different loan types will suit different buyers with different expected cashflows and interest rate expectations. There is no one right answer, nor is there one incorrect answer. Try to establish what you can afford to pay and consider what may happen if interest rates were to increase and how this may impact your ability to repay a home loan.
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Buying property is one of the biggest money decisions you’ll make in your life, so put in the work to get it right. Get good help around you so you cover all your bases and can confidently buy property knowing you’re on the right track from the moment you make your purchase!
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