Variable, Fixed or Split Home Loans?

The main drawback of a variable loan is that as the Reserve Bank of Australia (RBA) puts up the official interest rate, lenders will also put up their variable rates by the same margin. The nightmare 17% percent rates of the 1980s may make some borrowers cautious about variable loans, but these extreme rates are unlikely to recur in the foreseeable future. However there may be further interest rate rises during 2007, as the economy is reasonably strong, inflation is quite high, and unemployment is at a record low.

The main benefit of a variable loan is that you can generally make some extra payments without financial penalties, which will enable you to pay off the loan faster, saving you a lot of money in interest payments. Another advantage of variable loans is the honeymoon period. This is when a discounted rate is offered, for usually one year, but as short as six months, or as long as three to four years.

The honeymoon rate can take two forms, the first being a fixed discount, and the second being a discounted fixed rate. The fixed discount is actually a variable rate, but fixed at a certain margin below the standard variable rate. So if the standard rate moves up or down, so will the discounted rate by the same percentage. In contrast, the discounted fixed rate remains the same for the honeymoon period, regardless of any movements in the standard variable rate.

At the end of the honeymoon period the loan will roll over to the standard variable rate. Occasionally with some of the smaller lenders the new rate could be higher than the standard rate. Some lenders may cap or limit the amount of extra money you can pay off the loan during the honeymoon period, which may negate the benefit of taking out a variable loan with a honeymoon period.  You also have to pay large exit fees if you pay out the loan or refinance at the end of the honeymoon period. This discourages borrowers from jumping from honeymoon product to honeymoon product.

Fixed interest rate loans allow you to fix your interest rate for a specified period of time. This is usually between one and five years, but some lenders will allow you to fix the loan for up to ten years. However the current fixed rate is generally higher than the standard variable rate.

When your fixed rate period has expired you can renegotiate another fixed rate period, but the actual rate may be different to the previous one, as fixed rates rise and fall just as variable rates do. If you do not renegotiate, your loan will usually roll over to the current standard variable loan. Fixed rate loans may carry penalties for making extra payments.

A split loan allows you to have part of the loan as a variable rate and part as a fixed rate.
This protects you in periods of successive interest rate rises.

For information on mortgages go to http://www.creditworld.com.au/home-loans.html.

Summary

• Variable loan interest rates move up or down with the official interest rate set by the Reserve Bank of Australia (RBA).
• Variable loans may have a honeymoon period, usually for one year. One alternative is a fixed discount where the rate is set by a certain margin below the standard variable rate, with which it moves up or down. The second alternative is a discount rate for the entire honeymoon period.
• Variable loans usually allow you to make extra payments without financial penalty, allowing you to pay off the loan faster.
• Fixed rate loans have an interest rate fixed for a certain period, usually one to five years.
• At the end of the fixed period you can renegotiate, or the loan will roll over to the current standard variable rate. If you renegotiate, the new fixed rate may be different from the old one.
• You can take out a split loan with part variable and part fixed rates.

Article correct at its author date: Jan 2007. Copyright Virtual Office Space, Any unauthorised reproduction of this article will be prosecuted to the full extent of the law. Credit Cards Australia.

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