What is a variable rate home loan?

When it comes to getting a home loan, you’ll usually have two options to choose from: a fixed rate home loan or a variable rate home loan.

Depending on what you’re looking for in terms of features and flexibility, one option may suit you more than the other. For example, if you’re looking for a locked-in rate of a period of time, a fixed rate might be attractive.

On the other hand, if you want to have and use an offset sub-account, have the ability to make extra repayments or simply want some added flexibility - a variable rate home loan may be the one for you.

What is a variable rate?

You may have a very base-level understanding of what interest rates are, but let’s clearly define what a variable interest rate is.

Variable interest rates can fluctuate, up or down, in line with the market. Unlike fixed rates, which can be locked in for one to five years (generally), variable interest rates can and likely will change over time.

For example, when the Reserve Bank of Australia (RBA) cut the cash rate to 0.10% in November 2020, interest rates hit historic lows. There were even some interest rates being offered at less than 2%.

Now as the RBA has increased the cash rate multiple times this year, we have seen lenders increase their interest rates too.

But the cash rate isn’t the only influencing factor on variable interest rates. Other things like general market activity, lending restrictions (e.g. APRA tightening its serviceability buffer from 2.5 to 3%), and your lenders' funding costs and business decisions can impact their interest rates being offered.

Key differences between fixed and variable rates

There are a few differences between fixed and variable interest rates.

Variable rates can change, fixed rates don’t

As mentioned, variable interest rates will change in line with market activity. On the other hand, fixed interest rates remain ‘fixed’ for a period of time.

For example, if you locked in a two-year fixed interest rate, your interest rate will remain the same for two years. But when the two years are up, your interest rate will revert to your lenders' standard variable rate.

During this two-year period, your variable rate could go up or down. If you’re on a fixed interest rate, you wouldn’t benefit from interest rate cuts, but you wouldn’t be impacted by interest rate increases either.

Variable rate home loans are more flexible

With a variable rate home loan, you may have additional features like an offset sub-account, redraw facility, ability to make unlimited extra repayments and more.

An offset sub-account is a linked to your home loan, and any money deposited into this account is ‘offset’ against your loan’s principal. As a result, you will only be charged interest on the difference.

For example, if you have a 100% offset sub-account, your home loan principal is $300,000, and you have $100,000 in an offset sub-account, you will only be charged interest on $200,000.

Additionally, unlimited extra repayments is exactly what it sounds like: you can make unlimited extra repayments. A redraw facility allows you to tap into your equity, which you will then need to pay back later.

The flexible features of a variable rate home loan can help you pay off your loan quicker, and pay less interest in doing so.

With a fixed rate home loan, you will either be unable to make extra repayments, or you’ll be limited in how many you can make. You’re also unlikely to have features like an offset sub-account or redraw facility.

Fixed rates can be helpful for budgeting

When you have a fixed rate home loan, you know exactly how much your monthly repayments will be. With a variable rate home loan, your monthly repayments could change when interest rates go up or down.

For this reason, a fixed interest rate can be helpful for budgeting purposes, as you know exactly how much you’ll spend on your mortgage each month. A variable rate can change, but it can also be helpful when its flexibility and features are utilised.

Pros and cons of variable rate home loans

To clearly understand the potential pros and cons of variable rate home loans, let’s go over a classic pros and cons list.

Pros

With a variable rate loan, you have added flexibility which you may not have with a fixed rate. You may have the ability to make extra repayments (if you want to), access a redraw facility, and you may be able to pay off your mortgage before its loan term without incurring break fees.

Additionally, having features like an offset sub-account, redraw facility, extra repayments and so on at your disposal can be helpful in paying off your mortgage quicker and paying less interest.

Another way you could pay less interest is if interest rates go down. If interest rates are generally trending downwards, chances are, your lender may cut its variable interest rates too.

Cons

The main con of a variable interest rate is that interest rates can go up. If the market shows interest rates are generally trending upwards, or the RBA increases the cash rate for example, your lender is also likely going to increase its interest rates. This is because their costs may increase, and so they pass this added expense onto you (the consumer).

It can also be harder to budget if interest rates do trend upwards as your monthly repayments may change. This can be particularly challenging if you’re on a tight budget or have other debts you need to service.

If you’re in the market for a low-rate variable home loan, check out our range of home loan products here. You can also reach out to one of our friendly lending specialists if you’re ready to get an application started.

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