Understanding Fixed Rate & Floating Rate Loans


There are two interest rate options available to you when setting up a home loan: A floating rate loan or a fixed rate loan.

 

Which is Which?

A floating rate loan is when the interest rate charged by your lender may vary throughout the life of the loan according to market conditions and indicators such as the Reserve Bank's official cash rate.

This means that the rate associated with your loan can go up, and it can also come down at any time during the loan.

A fixed rate loan is a loan where the interest rate applied to your loan does not change for the duration of the fixed term. For example, if you have fixed a loan at 5.75% p.a. for three years, then your interest rate for that duration will not alter from 5.75% p.a.

 

What’s Right For You?

It really depends on your personal circumstances. If you are on a tight budget, you may prefer the comfort of a fixed rate knowing that in the future, if lenders increase their floating rates, your rate will remain the same for as long as you choose to fix it.

Conversely, if lenders reduce their floating rates according to market forces, you will not benefit from the lower interest rates whilst your loan remains locked in a fixed rate term.

When the fixed rate term expires, the loan will generally revert to the lender’s standard floating rate applicable at the time.

Fixed rate loans are often less flexible than floating ones. For example, making extra repayments to reduce your loan balance is often restricted with a fixed rate loan.

A borrower who needs flexibility and has the capacity to manage future rate rises may opt for a floating rate loan. Although they will have to pay more if the rate increases, they will also benefit from any rate reductions.

The penalties for breaking a fixed rate contract can be expensive, so before fixing your rate, make sure the key features and conditions of your chosen loan are right for you.

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