Do you prefer to have everything mapped out exactly when planning your budget, or are you happy to allow a little room for uncertainty, in the hopes that future events will play out to your advantage? This is the choice you face when deciding between variable or fixed interest rates on your home loan.
Variable vs fixed interest rate: Which is in your best interest?
The interest rate is essentially the cost of borrowing. When you take a home loan from the bank, you pay back the loan in installments, along with an additional amount determined by the interest rate, which can change over time in response to market forces.
Or at least, that’s the standard option, otherwise known as the variable interest rate. In most cases, the bank will present you with the alternative of a fixed and variable rate mortgage, where the interest rate remains the same for an initial period of the loan, regardless of market forces, and then, after that initial period, returns to a variable rate mortgage. This will be offered after your bond has been registered with the bank.
So, which option should you choose? Let’s run over the pros and cons of each.
Variable interest rate
- Pro: If the prime interest rates go down in response to market forces, the interest on your home loan goes down with it, and you save money.
- Con: On the other hand, if the prime interest rate goes up, so do your repayments. The fluctuating interest rates can make it difficult to budget accordingly.
Fixed interest rate
- Pro: You keep paying the same amount of interest, regardless of fluctuations in the market, for an initial agreed period. You will thus be able to factor interest rates into your budget with 100% accuracy.
- Con: First of all, a fixed interest rate may be less of a risk for you, but it’s more of a risk for the bank, so they’re likely to charge you a higher rate out the gate. Secondly, fixed interest rates expire after the initial agreed period, after which you will either have to revert to variable interest rates, or negotiate a new fixed rate with the bank.
- Con: The option of a fixed interest rate for the initial agreed period is only offered after bond registration, so you cannot factor this in to your planning upfront.
So ultimately, the best choice depends on your situation. The fixed interest rate is probably the right choice if:
a) Your budget is tight and you can’t afford any additional expenses
b) Market conditions seem to suggest that interest rates will rise in the near-future
Prime interest rate vs your personal interest rate
Bear in mind all the ways in which you can obtain more favourable interest rates on a home loan without having to rely on market forces. For example, clearing your credit record, which is one of the factors banks use to ascertain how risky it will be for them to lend you money; as well as placing a deposit on the property, which negates some of the risk for the bank and thus lowers your interest rate.
Banks have different credit and pricing policies and some banks may grant you a more favourable rate versus another bank. The services of a home loan comparison service, such as ooba home loans, can be helpful in this regard, as they apply to multiple banks on your behalf.
ooba home loans also offers a range of tools that can make the home-buying process a lot easier. To calculate your monthly bond repayments at different interest rates, use ooba’s bond repayment calculator. Then you can use the ooba Bond Indicator, a free, online prequalification tool, to determine your credit score and what you can realistically afford. Finally, when you’re ready, you can apply for a home loan.