Choosing the right mortgage solution of variable fixed or both

Even though I meet dozens of people a week and help them finance a variety of purchases, from first homes to mega upgrades through to complex investments, there’s still one question that comes up more often than others.

Should I fix my mortgage interest rate or go with variable?

For decades, whether rates were up or down, or not moving whatsoever, this is a query that’s come up. And it’s a really important question to consider, given there are pros and cons to both.

Right now, when there’s uncertainty in the mortgage market, when cost-of-living pressures persist, and when there are some enticing property opportunities out there to be seized upon, it’s an especially pertinent query.

When you’re making major decisions like these, it’s always important to consider your personal circumstances and your long-term goals. It’s also crucial to engage a qualified and experienced financial expert to help guide you through what is often a complex scenario.

It’s complex because there are pros and cons to each option.

First, let’s go back to basics given the rapid movements in lending over the past few years might’ve created some confusion.

When you fix your home loan, you’re essentially agreeing with your bank that the interest rate applied to your mortgage won’t change for a certain period of time. Statistics show this as the average fixed rate term is three years, although it can be as little as one year and up to five. Some lenders even go longer than that in certain circumstances.

When you’re fixed, any increases in the official cash rate, quickly adopted by the banks and passed on to borrowers, won’t impact you. You pay the same amount each month no matter what.

On the other hand, a variable interest rate does exactly what it says on the box. It varies. When the Reserve Bank hikes the official cash rate, lenders almost always follow suit and your repayments will edge upwards by the same figure.

But likewise, when the cash rate begins to fall, those savings also flow through to Australians paying off home loans via a variable interest rate mortgage. Although, it should be noted that historically rate cuts haven’t always been passed on in full by some lenders. That’s sparked a bit of controversy in the past.

Whereas, if you are on a fixed rate mortgage, and the cash rate reduces, then you are locked in to the higher rate with no ability to negotiate with your lender, unless you are willing to pay a penalty.

It’s the main reason why you should tread very carefully before making any decision to fix your rate or remain variable.

Both options require a borrower to bank on a few assumptions, no pun intended. For those fixing, it’s generally a bet that rates won’t fall too much below where they currently sit, so you’re paying way above what the rest of the market is. For those going variable, the hope is that rates fall and you’ll reap the benefits.

The general wisdom might be that fixing your home loan ahead of an anticipated reduction in interest rates might not be the best choice.

And there’s definitely some truth in that.

But there are a few things to consider. The first is that the Reserve Bank’s path out of high interest rates is still a little uncertain. There’s stubbornly high inflation, which isn’t where it should be by now, and a bit of a shaky economic climate to consider.

The other thing to keep in mind is that fixing your mortgage isn’t just about cost savings.

Four years ago, when interest rates were at historic lows, locking in an almost unbelievable figure for a few years would’ve been a great way of saving money. That’s especially true given where we find ourselves now.

But for a number of mortgage holders, fixing is about something that’s often more valuable than a dollar figure. Certainty.

Knowing that what you’re paying each month in home loan repayments isn’t going to change, no matter what the Reserve Bank and your lender do, has a lot of benefit for many Australians. That’s especially true at the moment when household budgets are stretched.

Another point to keep in mind is that some lenders have begun discounting their fixed mortgage interest rates. They can see a time soon when the Reserve Bank begins cutting so they’re getting of the curve.

So, if a bit of certainty is what you’re after, you can secure it for a lower rate at the moment.

But there are some cons, and the big one is that by fixing you trade in virtually all of your flexibility that comes with a variable arrangement. 

For example, say you fix now for three years but then decide in nine months or so that you’re going to sell that property for whatever reason. The bank won’t gleefully wish you well without some kind of consequence and you’ll be slapped with a pretty hefty break fee, which could be tens of thousands of dollars depending on the circumstances.

And, of course, if you fix now for a long period and Australia sees an extended run of multiple, generous rate cuts, you could find yourself forking out considerably more than you otherwise would’ve. 

A number of other downsides to fixing, that are often overlooked, are that you can’t have an offset account linked to a fixed rate mortgage. This can be substantial benefit to many borrowers that will outweigh the certainty of a fixed rate.

Other things that are restricted on a fixed rate mortgage are the additional repayments (generally capped at a maximum of $10k extra per annum) and also redraw is not available on a fixed rate mortgage.

All very important things to consider.

Opting for a variable loan gives you a certain sense of freedom. Firstly, you’re not locked into any kind of commitment, whether it’s the rate you pay or for how long you’re bound by that arrangement.

It also means that if rates start reducing, you get to bag that cost saving each month when it comes through from your bank. And that’s a pretty sweet spot to be in right now… right?

And all the benefits of an offset account, lump sum repayments and redraw are available which is great for variable mortgage holders.

Only a few months back, virtually everyone was talking with supreme confidence about a looming rate cut by the Reserve Bank.

The war on inflation looked like it was being won, other economic factors were largely sound, and forecasts were that mortgage holders battling years of rate pain were in for a reprieve any moment now.

Things have changed just a bit recently. Now, the long-term outlook is a bit patchier. Yes, rates will come down, but when, and how often, and by how much is a little unclear.

Although, the broad consensus among economists is that the worst is probably over, so substantial increases in the near term are pretty unlikely. So, staying variable means that there’s flexibility there to strap in for a breezy downhill descent.

So, staying variable might make sense if you’re keen to see some relief to your budget and free up cash for other things.

The discussion about whether to fix or whether to stay variable often ignores a third option, which is to do a combination of both.

It’s possible to fix only part of your home loan, so a portion of what you’ve borrowed is subject to a rate that doesn’t change for an agreed period of time. The rest of it remains variable, so it’s kind of like you’re hedging your bets and spreading the risk.

For some people, especially those who want a bit of financial certainty without potentially missing out on rate reduction cost savings to come, this could be an attractive proposition.

It might mean that you’re balancing the cons of both to maximise the pros of each. In a climate like this, when the tea leaves seem to change regularly, that might be a particularly attractive idea.

In our experience, borrowers will split their home loan to give them both rate certainty and also the flexibility of extra repayments, redraw and an offset account and enjoy the best of both worlds.

And investors, especially those with multiple loans, often fix some loans – and very often across different loan terms so they enjoy different expiry dates and can manage their interest rate risks more proactively – as well as keeping some variable. Some will tie a fixed rate to an interest only term and others simply lock in for the certainty of repayment. Bearing in mind, rental income largely offsets any repayments, many investors will enjoy the fixed rate benefits because they know their exact monthly out of pocket expenses each month, and can easily budget for this.

So, in summary, there are many options and many things to consider but in general, the over-riding factor in any situation is your own personal circumstances. And this is where a good mortgage adviser can assist you with those decisions and considerations before making that call.