Is it time to lock in your home loan

One of the choices you need to make when taking out a home loan is whether to opt for a variable rate home loan or a fixed interest rate home loan.

While you can't change interest rates, you do have control over the amount you save or spend each week. Even an extra $5 per week paid off your home loan can make a real difference over time.

There are many advantages and disadvantages to choosing a variable rate home loan or a fixed rate home loan and the choice you make will depend on which type of home loan best suits your circumstances. Below is a quick summary of the pros and cons of each type of home loan.

Variable rate: pros

• You may get a 'honeymoon' rate for the first year, which means you start with a lower repayment

• If interest rates drop, so does your payment. This frees up money or allows you to pay more off the principal

• It's generally easier to increase or decrease your monthly repayments if your circumstances change

• Low or no penalty for paying off the loan early

Variable rate: cons

• If interest rates go up, so does your payments

• If rates go too high, you may be forced to sell if you cant make your monthly repayments

Fixed rate: pros

• The interest rate won't change for the fixed rate period even if standard interest rates do

• The repayment amount won't change so it's easier for you to budget for repayments

Fixed rate: cons

• If rates go down, you miss out on lower repayments

• You may have to pay fees to switch from a variable to a fixed-rate loan

• Fixed rate loans are generally less flexible with sometimes heavy penalties if you pay out early or refinance

Why the fee to pay out a fixed rate home loan?

Each lenders will have a different name for the fees when you pay out a fixed rate home loan - break fees, economic cost, exit fee, early repayment adjustment, prepayment fee. Most mortgage lenders will allow you to pay a small amount off your loan each year without charge. But if you go over this amount or pay out the home loan, you will be charged this fee.

When a bank funds a fixed rate loan, they borrow money from the wholesale money markets. Their interest rate is locked in at the same time as yours, but if the bank doesn't have the option to repay their loan early. So, when you repay yours, they still have to pay the interest on their loan.

If the cost of borrowing money on the wholesale market has dropped between when you fixed your rate and when you pay off your loan, the bank has an 'economic cost' to carry until they can repay their loan. They pass this cost on to you as a break fee.

Best of both worlds?

While both fixed and variable rate home loans have their benefits, you may be able to split your loan into a fixed and a variable rate component. This allows you to take advantage of the lower variable rate and flexibility for part of your home loan and maintain the security of a fixed rate for the other component. For more information on a fixed rate home loan, standard variable home loan or to find out if a split home loan is suitable for your needs and circumstances, speak to an Intellichoice mortgage broker by calling 1300 55 10 45.