Here’s an example. Consider Pete: he’s purchased a house with a variable rate home loan. Pete’s home loan has an interest rate of 2.50% p.a.
Following the Reserve Bank of Australia’s (RBA) cash rate reduction, Pete’s bank decides to reduce the interest rate of Pete’s variable rate home loan to 2.25%. Now, Pete doesn’t have to pay as much each month, although he can choose to pay more if he wants.
Your bank will decide when to change its own rates and by how much, but they’ll be influenced by the RBA. The RBA meets on the first Tuesday of every month (except January). During this meeting, the RBA decides the official cash rate. Depending on the decision made, it can place upward or downward pressure on lending rates, although it doesn’t mean that home loan rates will change. Some lenders choose not to pass on any interest rate decreases or increases, and no matter what they do, they’re required by law to tell you in writing.
There is a formula to describe how much interest you actually get charged with a variable rate loan:
(Outstanding loan balance x interest rate) / number of days per year = your daily interest charge
Your daily interest charges are then added together and generally charged to your home loan monthly but can also be charged fortnightly or weekly.
There are multiple types of home loans beyond just variable and fixed. You can also get a principal and interest (P&I) loan or an interest-only (IO) loan.
Variable home loans tend to be a bit more flexible than their fixed counterparts and can offer the following common features. These features might not be available in some cases, like if you have an interest-only loan.
Every time you make a repayment to your home loan, it decreases the amount owing on the loan, and making extra repayments can help pay off the loan faster. If your home loan has a redraw feature, you can also withdraw these extra repayments when you need them up to the loan limit. This can cancel out the benefit of making these extra repayments, however.
An offset account is a type of bank account connected to your home loan. The amount that sits in the offset account will reduce the interest payable on your home loan. Say you have $100,000 owing on your home loan. If you have $10,000 in a 100% offset account, your lender will only charge interest on $90,000.
Some lenders will let you ‘split’ your home loan between variable and fixed repayments for a period, and this split can be flexible based on what you want. For example, you could have a 50:50 variable-fixed split, which means 50% of your home loan will have a fixed interest rate, and the other 50% of your home loan will have a variable interest rate. A split home loan can sometimes get you the best of both worlds.
You need to decide for yourself whether a fixed or variable interest rate is right for your situation. Both types of loans have their benefits.
|Benefits of a variable rate mortgage||Risks of a variable rate mortgage|
|Generally more features than fixed-rate products||Additional features can be misused|
|Allows you to enjoy a lower interest rate if your bank decides to pass one on.||At the mercy of the market and your lender when it comes to future rate rises.|
You can apply to switch from a fixed loan to a variable one at any time in most cases. But to switch lenders you’ll have to be approved for refinancing, and on top of the various home loan switching charges you might face, you could possibly cop a high break fee, which can be thousands of dollars.
Ideally, a good time to switch from a fixed home loan to a variable one is at the end of your fixed-term, as your interest rate might revert to your lender’s standard variable rate. These are often much higher than what you can get by shopping around.