GUIDES & RESOURCES

Variable Rate Home Loans

Buying a house isn’t as easy as it once seemed, when you were five years old, sitting on the floor of your mortgage-free cubby house. But with the flexibility of a variable rate home loan, it’s easier than you might think.
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What is a variable rate home loan?

A variable rate home loan has a variable interest rate, which means the interest rate you pay can fluctuate1. What causes the interest rate to go up and down? Well, it could because of a few things:  changes in the market interest rates, business decisions made by your lender or the performance of the official cash rate (OCR). If OCR sounds a bit like gibberish, jump to the next question.

What is the ‘Official Cash Rate’?

The official cash rate (OCR) is the rate of interest set by the Reserve Bank of Australia (RBA) on overnight loans to commercial banks, so it has a big influence on home loan interest rates2. Think of it as a benchmark for interest rates. When the OCR goes up or down, lenders typically adjust their interest rates.

This means you might end up paying more or less interest on your variable home loan, depending on the movement of the OCR. But it’s important to remember that it’s up to your lender whether they pass on any rate changes. They can also change the interest rate on variable home loans independent of the RBA.

If the interest rate increases, how much can it affect the cost of my repayments?

It depends on how much the interest rate increases or decreases. But here’s an example of how a 1.00% variation in interest rate can impact your monthly repayments, based on a $500,000 loan over a 25-year term:

Loan Amount

Monthly repayment at 4.0% per annum

Monthly repayment at 4.5% per annum Monthly repayment at  5.0% per annum
$500,000.00 $2,639.00 $2,779.00 $2,923.00

This is a general example. This table should not be relied on for your personal situation.

As you can see, a change of just 1% to your mortgage’s interest rate could have you paying a lot more. Or less if the interest rate goes down.

There’s no conclusive way of knowing when the interest rate will change. A media release is issued at 2.30 pm after each monthly Reserve Bank Board meeting2, with any changes in the cash rate taking effect the next day. But it’s important to note that your lender isn’t actually required to follow the RBA, it’s only a recommendation. If they do decide to lower or increase the rate, they’ll notify you. Over the last 5 year period, the RBA has dropped the cash rate from 1.5% to 0.25% 3.

What is the difference between a basic variable and a standard variable home loan?

You’ve typically got two choices when it comes to variable rate home loans: standard and basic.

Standard Variable Rate Home Loans:

Standard variable home loans often offer a discounted interest rate, along with extra features that could potentially help you pay off your loan faster and save you more money in the long run. Some of these include:

  • Offset accounts: an offset account is a transactional savings account in which the balance of your savings is offset from the principal, reducing your interest payments. If you have a loan balance of $100,000, with $20,000 in an offset account, you only pay interest on $80,000.

  • Redraw facilities: redraw facilities allow you to access additional funds you’ve paid on top of your minimum loan repayments. The funds in your redraw facility also offset your loan balance and reduce your interest payable.

  • Additional payments: some loans allow you to make extra repayments without fees or charges, which may help you pay off your home loan quicker.

  • Pay off early: standard home loans usually come with less restrictions on making extra repayments, which means you might even be able to pay off your home loan before the full term.

Basic Variable Rate Home Loans

Basic variable home loans typically lack the extra features. So why would you pick a basic variable home loan? Well, they generally offer a lower interest rate than standard variable loans. This can make basic variable rate home loans an attractive option for first home buyers and those trying to keep costs down.

How is a variable home loan different to a fixed rate home loan?

Before settling on a home loan, you should consider whether you want a variable rate home loan, fixed rate home loan or a combination of the both, which is known as a split home loan. Here are some of the key differences:

Variable Rate Home Loans:

  • Your interest rate can go up and down
  • Interest rate typically responds to the official cash rate (OCR)
  • You can make extra repayments on top of your monthly repayments. This could help you pay off your home loan sooner
  • More flexibility
  • Opportunity to use loan features, such as an offset account

Fixed Rate Home Loans:

  • Your interest rate is fixed for a certain period of time, usually between 1 to 5 years
  • Fixed rate home loans are technically not responsive to the OCR, but in theory, their fixed interest rates have already accounted for its short-term rises and falls
  • Less flexibility

Split Rate Home Loan:

  • Essentially in a split home loan, you are splitting your home loan into two separate loans. You can assign different portions of your outstanding loan amount to the separate loans and these can be fixed or variable.
  • This way you get the best of both worlds: you know what your monthly repayments will cost on the fixed portion and if the interest rates drop you might benefit from the rates going down on your variable loan. If rates increase, the fixed portion of your home loan will remain unaffected.

What are the benefits of a variable home loan?

When it comes to a fixed home loan, it can be quite hard to make extra repayments, access your funds and payout your mortgage. But with a variable rate home loan you’ll find you generally have a lot more flexibility. It’s important to check with your lender what you can and can’t do before signing up, but you’ll find variable home loans often allow you to:

  • Make additional repayments: as you pay off your monthly or fortnightly repayments, most lenders allow you to make extra repayments. This might allow you to pay off your home loan sooner and as a result pay less interest. This is great to take advantage of when you receive large sums of money, such as a tax refund which you can transfer directly to your loan balance.

  • Move or sell your home: with a fixed home loan you often have to pay a fee if you pay down your mortgage when you decide to move or sell your home. Typically, variable home loans won’t charge you

  • Easy refinancing: with a variable rate home loan, you can refinance whenever you want and won’t have to worry about the break costs that are often charged on fixed rate loans.

What are the disadvantages of a variable home loan?

  • Changing interest rate: with a variable rate home loan your interest rate is at the mercy of the RBA’s cash rate and your lender. While this could be a good thing if the interest rate drops, you might find yourself paying more if the rate goes up. It’s also important to note that lenders aren’t actually required to follow the RBA and as result they may not pass the full interest rate increase or decrease4.
  • Difficult to budget: with the changing interest rate it can be hard to plan out your repayments and budget for the year.

Who do variable rate home loans typically suit?

Basic variable home loans may offer a lower interest rate, so they can be a good choice for first-home buyers who need a simple, low-cost loan.

Standard variable home loans may be suited to those who want more flexibility in their home loans. For example, determined budgeters might like having the option to make additional repayments, so they can reduce the overall cost of the loan and pay it off ahead of schedule.

How can I find a good deal on my variable home loan rate?

It’s not just about finding the lowest variable home loan rate, but finding one that’s suitable for your unique situation. So, what are some of the features you should look for?

  • Competitive interest rate: even though your interest rate might fluctuate with a variable home loan, you still want to look for the most competitive rate before signing up.
  • Flexible features: the biggest advantage of a variable rate home loan is the features. So make sure you use them! For example, you could set up an offset account or make extra repayments. All these things could help you pay off your home loan sooner.
  • Low fees: there are certain fees you should look out for when you sign up to a home loan. For example, an application or valuation fee, as well as any ongoing fees, which might be charged monthly or annually. TIP: weigh up the cost of these in relation to your interest rate. Sometimes it might be worth paying a small fee to land a lower interest rate.

Before you sign up, compare a range of different lenders and have open conversations with them about your needs and repayment capacity. Remember that lenders aren’t actually required to follow the RBA cash rate. So it’s important to make sure you’re comfortable with the changing rate.

Compare variable rate home loans with iSelect’s partner, Lendi

Want some help comparing? iSelect has partnered with Lendi to make this process a whole lot easier. Get started comparing home loans from 35+ lenders online the easy way, or give Lendi a call on 1300 18620 (08:30-18:30).

Sources:
1. https://moneysmart.gov.au/home-loans/choosing-a-home-loan
2. https://www.rba.gov.au/statistics/cash-rate/
3. https://tradingeconomics.com/australia/loans-to-private-sector
4. https://www.rba.gov.au/qa/

Last Updated: 10/11/2020

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