Regardless of whether you’re refinancing your loan or a first home buyer, one of the biggest decisions you'll have to make when taking out a loan is whether to choose a variable or fixed-rate loan.
Variable loans are quite popular for good reason. They can give you flexibility to pay off a bit more when you have some spare cash, and usually don’t leave you with a hefty “break fee” if you have to end or change your loan earlier than expected. But there are some things you should consider when looking at a variable loan.
What goes down may go up
The biggest catch with variable loans is that the interest rate may change, whereas the rate on a fixed-rate loan won’t move for the period it is fixed. It may sound obvious, but this means that the amount you pay each month will change if the interest rate moves, which may be a surprise if you’re on a tight budget. Right now, rates are at an all-time low, but there’s always the chance that the Reserve Bank or lenders will increase them. While no one knows exactly if or when this will happen, APRA suggests that you factor in at least a 2 per cent rate increase when budgeting.
An easy way to do this is to use Pepper's home loan repayment calculator. Just go to the interest rate and add another 2 per cent to see what your repayments will be if rates rise. If the higher repayment amount looks affordable, then you’ll have a good buffer just in case there's a rate increase.
Of course what goes up may also come down, and one of the good things about a variable loan is that your repayments may also go down if interest rates are cut.
Check the comparison rate
Another thing to be aware of with variable loans, and also fixed-rate loans, is that your repayments may include other charges like set-up or monthly fees. Thankfully, lenders are also required to provide you with a comparison rate, which shows what rate you might actually pay on your loan by including these additional charges. Remember that comparison rates are a guide only and do not include all fees and charges. Every circumstance is different so read the fine print to see how the loan amount and fees affect the rate.
Another simple way to look at this is by comparing the monthly repayments on different loans. This will show you the actual number of hard-earned dollars you’ll pay out every month on each loan, so you can compare apples with apples.