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When you purchase a house you'll have to choose between Variable or Fixed. This refers to how interest rate structure of the life of your loan. Deciding which is best depends on your long-term goals.
The Allure and Risks of Fixed Interest Rates
Fixed-rate home loans are particularly appealing due to their initial stability and predictability. They allow homeowners to lock in an interest rate for a period, usually between one to five years, resulting in consistent monthly repayments. This fixed period offers a shield against immediate fluctuations in the market, a boon during uncertain economic times.
However, this apparent stability can be deceptive, especially when low fixed rates are used as lures to attract new customers. For instance, during the COVID-19 pandemic, interest rates plummeted to as low as 2% as part of the Reserve Bank of Australia's efforts to stimulate the economy. This dramatic drop led to an influx of customers locking in low rates, under the assumption that their repayments would remain constant.
The challenge arises in the lack of understanding about the impact of interest rate changes. For example, on a $600,000 loan at a 2% interest rate, monthly repayments would be around $1,800. However, when interest rates spiked to nearly 7%, repayments jumped to over $3,300. Such an increase can be financially crippling for many, as they may not be able to afford the higher repayments once the fixed term ends and rates revert to higher variable rates.
Variable Interest Rates: Flexibility and Uncertainty
Variable interest rates, while offering flexibility, are susceptible to changes influenced by the Central Bank's policy decisions. The primary advantage of variable-rate home loans is the ability to make unlimited additional repayments, which can significantly reduce the overall interest payable and shorten the loan term.
However, the risk of variable rates lies in their unpredictability. Rates can increase based on economic conditions, leading to higher monthly repayments. This can pose a challenge for budgeting and financial planning, especially in volatile economic climates.
With a Variable rate structure, you can make unlimited additional repayments whereas in Fixed rates, you are capped. Which, if you’re in a position to make large additional payments, you would not be able to under a fixed structure.
With Variable, you’re susceptible to increases in interest rates, but also can benefit from drops in interest rates in good times. If you sign on to a fixed rate at 5%, and market rates drop, you stay at 5%. Whereas in a variable structure, you’ll enjoy the rate drop.
Key Considerations for Homeowners
The essential factor for homeowners is to prepare for future rate changes, regardless of the initial appeal of a low fixed rate. It's vital to assess not just the current affordability but also the potential for increased repayments in the future. This involves considering a 'buffer' to accommodate potential rate hikes and ensuring that your finances can withstand realistic interest rate changes.
Final Thoughts
In deciding between variable and fixed interest rates, Australian homeowners must weigh the predictability and stability of fixed rates against the flexibility and potential savings of variable rates. Understanding the impact of interest rate changes on monthly repayments is crucial. Homeowners should not only look at the present benefits of a low fixed rate but also prepare for the eventual return to higher variable rates.