Fixed Rate Loans Explained
If you've ever had or applied for a loan of any sort chances are you've been asked whether you would like a fixed or variable interest rate. Both have advantages and disadvantages and it really comes down to what you're looking for from your home loan. Below is a run down on fixed rate loans specifically.
When you get a fixed rate loan you're generally locking in an interest rate for between 1 and 5 years and whatever rate you've agreed to is what you will keep for the time you've selected. If the RBA moves rates, doesn't matter, up or down, you keep whatever you rate you settled on.
The Unfortunate Bits
There's a bit more to just keeping that rate for however long you keep the loan, specifically if you don't want to keep your loan for as long as you agreed to originally. Got a 5 year fixed loan and want to refinance or sell your property? Be prepared to pay break costs. They can be expensive and very prohibitive. I have a client that is about to refinance a loan, 2 years into a 3 year fixed term and the break costs are almost $10,000. It's not one size fits all as far as the costs of breaking a fixed term go either, depending on circumstances there can be no break costs, so if you are considering a fixed loan it is something you should discuss at length with your finance broker until you are absolutely comfortable making a decision moving forward.
If you were planning on paying extra off the loan you may need to reconsider if you are on a fixed term. Generally speaking you are limited to paying no more than $10,000 a year extra off your loan. If you do pay more the break costs equation comes back in to play. The costs are less because the amount is less than paying off a whole loan but still something to keep in mind. Also, if you're a fan of offset accounts they are a bit restricted on a fixed loan. If the loan has an offset account option the account is a 40% offset. If you have $100 in your offset account the bank will calculate the interest saving as if there was only $40. That said, off the top of my head I know of one bank that bucks both of these trends and offers unlimted extra repayments and a 100% offset facility but it is rare and those options may not always be offered.
The flip side of not worrying about your repayments going up due to rate increases, your repayments aren't going down when the cash rate is lowered. In a low rate environment such as the one we are in now it is hard to imagine rates getting any lower but people have been saying that for a couple of years now and they did get lowered. I would only pick fixed if you wanted it for the certainty.
The Better Bits
If you have a fixed rate loan with a 5 year loan term you know exactly what your repayments will be for 5 years. That's about it really for the better bits. You get certainty of what you need to be able to pay each month for a decent amount of time.
How to have your cake and eat it too.
In the words of the little girl that decides to have soft and hard tacos for dinner, "Why not have both?" You can split your loan into different portions, 1 half could be fixed and 1 variable, that way you can pay extra into the variable and have the certainty that your repayments can only change so much.