As you begin your journey towards homeownership, one of the most important decisions you’ll have to make involves the structure of your loan. The two main options available to you are a fixed rate loan and a variable rate loan, but knowing how to best structure your impending mortgage can be a confusing proposition.
The most important thing to understand is that one of these options is not inherently “better” than the other. They each have their own pros and cons, and you should choose the loan structure that makes the most sense for your personal circumstances and preferences. Only by first considering your long-term plans for the loan, along with your overall financial goals, will you be able to make the best decision that’s right for you.
A variable rate home loan is one that has an interest rate that the lender will increase or decrease over time depending on the market and other factors. If interest rates plummet after you buy your home, you don’t have to worry about going through a long and complicated refinancing process because the loan structure will essentially take care of that for you. However, the reverse is also true – if interest rates rise, so too will the rate associated with your loan.
There are a number of factors to consider before choosing a variable home loan. Overall, variable rate home loans are ideal for people who need additional flexibility with their loan structure. Likewise, if you have the ability to make extra repayments – meaning that you’re planning on paying off your home far sooner than the actual term – a variable rate home loan would be the ideal choice because you can save a tremendous amount of money on interest in the process. This is especially true in the current climate, when interest rates are at an all-time low in Australia of 0.25%.
Variable rate home loans are also ideal for people who want an offset account, which works like a normal transaction account (allowing you to deposit and withdraw as you please), but it is linked to your home loan. Each dollar that sits in your offset account directly offsets a dollar of your home loan, meaning if you have $10,000 in your offset account you don’t pay interest on the corresponding $10,000 of mortgage. Interest is calculated daily so holding funds in your offset account starts saving you interest right away! Learn more about offset accounts by watching our explainer video below.
Fixed rate home loans, on the other hand, are exactly what they sound like – a loan with an interest rate that remains the same for the entirety of a fixed rate period, normally between 1 – 5 years , regardless of what is going on in the real estate market. If you lock into an interest rate of 2.15% today and in five years rates climb to 5%, you’re still paying that same 2.15% no matter what.
Fixed rate home loans are usually ideal for people who want extra security. Homeowners looking for not only low repayments but also predictability in terms of how they’re budgeting their finances over the next few years should consider taking out a fixed rate home loan.
Keep in mind, however, that if interest rates drop below your current rate you don’t get that benefit unless you break your fixed agreement or refinance. Fixed rates themselves are very low, but they do come with a break cost if your circumstances change, and are often capped if you want to make extra repayments.
At Shore Financial, we’re proud of the fact that we’re one of the few brokerages that have access to a product that can allow homeowners to take advantage of an offset account on a fixed rate loan – usually, these are tied to variable rate loans only. This is rare in the industry, and it’s another in a long line of examples of the commitment that we’ve always shown for our valued customers.
In terms of your repayment structure, two other important concepts to understand take the form of P&I (principal and interest) loans and IO (interest-only) loans.
With the former, all of your monthly mortgage repayments are divided up into two sections. Some of that money is used to pay the bank interest, while everything else goes towards paying off the principal (i.e. the original loan amount) over time. At the start of your mortgage, your repayments will mostly be paying the interest payable on the loan, but as you progress through the loan period the proportion of principal repayment will increase. But with interest only loans, you’re not actually paying down the debt – you’re just paying interest throughout the entire interest-only period.
P&I loans allow you to build equity in the property, which is perfect if it’s your “forever home” or if you see it as a long-term investment as opposed to a short-term one.
IO loans, on the other hand, are very popular with first-time home buyers or investors because payments are much lower, thanks to the fact that you’re only paying interest and not the home loan debt itself. Investors also find this ideal because they can maximize their tax deductions using this method.
If you’re having trouble choosing between fixed and variable, note that it is possible for you to split your mortgage into two separate loans- one portion that is charged at a variable rate, and the other that is charged at a fixed rate. This is an effective way to get the best of both worlds; enabling you to manage the risk of interest rate fluctuations with the fixed component, but also take advantage of depreciating rates and an offset account with the variable component.
Overall, the main factors that you should consider before choosing a loan structure are:
Your Risk Appetite: Are you willing to bet that interest rates will continue to drop and want to take advantage of that when it happens? If you are, a variable rate mortgage is the way to go. If you want to lock into an already low rate and be done with it, a fixed rate option is better.
How Much You Value Flexibility: Along the same lines, do you value the flexibility of a variable rate loan structure or do you desire more predictable rates and payments offered by a fixed rate? That’s a question only you can answer.
Whether You Want an Offset Account: If you’re planning on using an offset account at all and have the ability to make extra repayments, a variable rate home loan is the obvious choice. Unless you choose to partner with Shore Financial, of course, as we have options that allow you to offset on a fixed rate mortgage, too – something that is very rare in the industry today.
How much you can afford to repay: If you’re looking to minimise your mortgage repayments, an interest-only loan might be suitable for you, though this is to the detriment of building equity in the property.
At Shore Financial, we’re proud of the reputation we’ve been able to build as trusted experts in tailored home loan solutions. We understand that every homeowner is unique – everyone has their own specific goals and visions for what their future will look like. But regardless of what those goals happen to be, we have services that will help you accomplish every single one of them – all while helping you make the right decisions when it comes to your mortgage, absolutely no exceptions.
So if you’d like to find out more information about choosing a loan structure, check out our video below or get in touch with someone from Shore Financial today. Please don’t delay – contact us today.