A variable rate loan means the rate of interest can change at the discretion of the lender. Historically, lenders only changed the rate when the RBA changed the official cash rate and by the same margin. In recent years, lenders have broken away from that tradition and now make independent decisions based on their own internal calculations and taking into account their preferred positioning in the market. Borrowers need to be mindful of their current rate and how competitive it is relative to other lenders. A loan that was ‘cheap’ a couple of years ago may now be average and cost the borrower thousands of dollars more each year. Variable rate loans are also able to have offset transaction accounts linked to save on interest.

A fixed rate loan means the rate is locked for a number of years. Regardless of any variable rate fluctuations, your rate will not change during the fixed rate period. This is great for peace of mind and certainty about cash flow. The downside is that if you want to break that fixed rate contract for any reason like selling the property or wanting to refinance, there may be a penalty. The lender will calculate the penalty based on how long is left on the fixed rate period and what rate the funds can be reloaned at i.e. whether the bank will make a profit or loss on the funds available from the broken contract. The savings of a proposed refinance will need to take into account any fixed rate penalty to work out the net benefit. When the fixed rate period expires, the loan reverts a variable rate. This rate is often expensive if no discount has been pre negotiated when getting the loan originally. Typically, a fixed rate loan cant have an offset transaction accounts linked to save on interest.

There is also the option of a combination or split loan that has variable and fixed portions. We discuss this more in a separate post about combination loans. If you need a review of your loans to determine if they are still competitive and appropriate for your finance needs, we are happy to do a no obligation finance health check.