Home buying 101: fixed, variable and split rates explained

Do you know the difference between a fixed rate loan and a variable loan? What about a split rate? Which one offers you more advantage?

Read on to find out what fixed, variable and split rate loans are, and how the benefits they offer.

If you’re thinking about buying or building a home, you’ve probably come across plenty of confusing finance jargon in your search for the right loan. 

With fixed, variable and split rate options available, how do you know which is a better fit for your situation. How much will a variable loan rate cost you over the long term? What benefits come with a split rate loan? Does one type of rate benefit you more than the other?

Simplify your research by understanding your options. This quick and easy guide defines each type of loan along with its main benefits. Let’s get started …

What is a fixed rate home loan?

The easiest to understand and work with, the fixed rate loan is a loan in which your interest rate stays the same over a set period of time. For example, if you get a 25-year home loan with a fixed 4% rate, you will pay 4% interest over the full 25 year term. 

Pros

Budgeting: Because your mortgage payment will be the same month in, month out, you know how much you will need to budget for your bills.

Setting goals: It’s easier to save when you know how much you need to spend each month. With a set budget, you can make financial goals with confidence. 

Rate rises: Rate rise panic is not an issue for you. Regardless of what happens to interest rates over the term or your loan, you can rest assured that your repayments will stay the same.  

While this brings some certainty that can be a blessing when you’re trying to stick to a budget, it can also end up costing you more over the term of your loan. If interest rates drop, you will be locked in at the higher rate. 

What is a variable rate home loan?

A variable loan rate is a home loan with an interest rate that can change over the term of your loan. These rate changes are calculated in response to official cash rate or changes to your bank’s funding costs. 

For example, you may sign up for a 25-year home loan with a variable rate at 4%. Three years later, interest rates go up 3% and so does your home loan rate — to 7%.  Two more years pass and rates drop to an all time low. So does your home loan rate — to 2%.

Pros

Flexibility: Your lender will likely offer you more flexibility when it comes to paying off your variable loan rate. This can include making extra repayments at no extra cost, making it easier for you to pay off your loan sooner. 

Rate drops: You will reap all the rewards of rate drops every time they happen. If you’re savvy with your repayments, you can pay off your loan during low rate periods, which can save you thousands of dollars. 

More features: As mentioned, lenders are likely to be more flexible with variable rate loans, which means they often roll out a sweep of extra features. This can include offset accounts and unlimited redraw facilities to help you make your repayments.

Variable loan rates can have big benefits if interest rates are low and keep dropping, but rate rise panic is very much a thing when you’re working with a variable loan rate. This is especially true if you don’t budget for rate rises when shopping around for your home. 

What is a split rate home loan?

Split rate loans are exact as they sound — loans that allow you to split your loan into separate accounts, nominating a portion to a fixed interest rate account and the rest to a variable rate account. 

Let’s say you opt for a 25-year split rate loan in which 70% of the loan has a fixed rate of 4% and 30% of the loan has a variable rate starting at 4%. Three years later, interest rates go up 3%, which means you’re only paying the higher rate on 30% of your loan. The other 70% is locked in at 4%. 

Two more years pass and rates drop to 2%. You’ll still be paying 4% interest on 70% of your loan, but you’ll still get the benefit of the rate drop on 30% of your loan. 

Pros

Manage your risk: Split rate loans allow you to more effectively manage the risk and security of your loan by combining stability and flexibility.

Features: Lenders will often work with you on split rate loans, offering more flexibility in repayments than a 100% fixed rate loan. This can help you pay off your loan much quicker. 

Budgeting: Like a 100% fixed rate loan, split loans can help you budget more effectively by offering a degree of certainty in your monthly repayments. Of course, you can’t be 100% certain, but depending on how you divide your home loan, you can make pretty effective estimates.  

Split rate loans require a bit more work and research to effectively reap all the reward that they offer. If you’re keen on numbers and percentages, you may find this type of loan suits you best. If you’re not so keen on the fuss, you may want to stick with the other types.