The standard 30-year variable-rate mortgage is a home finance instrument that begins with a fixed interest rate for a specified period after the loan’s inception. Following this period, typically lasting three to ten years, the interest rate is subject to annual adjustments based on current market conditions and the ARM index rates.
In periods of low interest rates, variable or adjustable-rate mortgages (ARMs) may seem attractive to prospective homebuyers. Will that be the case throughout the entire loan term? Would it make sense to maintain an offset account vs. paying off a mortgage? Continue reading as we explore the advantages and drawbacks of each loan type.
Fixed Rate Home Loan Advantages
This loan category offers a constant rate throughout the entire duration. This provides predictability to the borrower, allowing you to budget effectively without worrying about monthly payment fluctuations. Here, the bank takes all the risk. If rates rise, they are left lending you money at a rate below the market if you’re locked in with your fixed-rate mortgage.
This protection against market volatility shields borrowers and especially appeals to those with a long-term financial plan. Typically, borrowers in this camp plan to be in their homes for a substantial duration. If you are looking to invest in a property in the long-term, securing a competitive fixed rate home loan may help you manage your mortgage repayments with greater certainty, even during the cost of living crisis.
Fixed Rate Home Loan Disadvantages
The main drawback is potentially higher initial rates compared to variable-rate loans. You are taking the risk that rates won’t be declining before your loan duration ends. Additionally, some fixed-rate loans include penalties for early repayment. This limits flexibility for borrowers who are able and willing to satisfy the debt early.
Simply put, if you’re hoping to secure a fixed rate home loan, it’s beneficial to secure a loan during periods with lower interest rates.
Variable Rate Home Loan Advantages
As the name suggests, ARMs offer dynamic interest rates once the up-front teaser rate period is completed. Afterwards, the rate is subject to adjustments within predetermined intervals outlined within the contract. These vary in length, but standard contracts include annual, every three, and every five years. Other periods may exist if negotiated between both parties.
The main advantage is the lower initial interest rate. You enjoy that advantage now because you’re taking the risk of rates rising in the future. In that case, your monthly payments will increase, and the equity gained on your home is delayed.
Though you may get lucky, rates could decrease. You’ll welcome this change since your monthly payments will decrease accordingly. So, this flexibility is the advantage since you stand to benefit twice from low rates, the initial rate period, and the scenario where rates drop.
Variable Rate Home Loan Disadvantages
The same volatility is the main drawback for variable-rate loans. Your uncertainty regarding rising rates means your monthly payments could increase dramatically. You may be forced to cut back your budget for other areas of your lifestyle to cover your mortgage payment.
One way to manage this risk is by selecting a loan with interest rate caps. These limits prevent your variable rate from rising past certain levels. Some caps limit the rate itself, others cap the amount your monthly payment can increase. Your contract might include another limit that defines a set number of years before your rate begins adjusting.
What’s The Best Option For You?
First, evaluate the market. Fixed-rate loans appeal more in a lower-rate environment, offering a stable, acceptable rate and low payments. If you expect rates to decrease, favour a variable rate mortgage to take advantage of the initial stability followed by a welcomed rate decrease.
Then, assess your risk tolerance for financial uncertainty. If you favour a predictable monthly payment, diligently shop around for a rate you’re comfortable with and lock it in. The fixed rate also aligns with those planning to live in the home for a considerable time. But if you plan to pay off the loan early, consider an ARM seriously.
Maintaining an offset account might make sense for some borrowers. Here, money in a transaction account is linked to your loan. The funds are offset against your outstanding mortgage balance instead of earning interest. This offset balance is subtracted from your principal when calculating interest.
For example, if you have a mortgage of $300,000 and an offset account containing $30,000, you only pay interest for the remaining $270,000. The main advantages are that since you reduce the outstanding principal, you pay less interest over the loan term and have access to the offset funds for emergencies.
The main advantage to paying off your mortgage early is that, like the offset account, you’ll enjoy interest savings. But you’ll also own the home outright much earlier. So if you value liquidity and continual funds access, an offset account may be favourable. A quicker avenue towards ownership is satisfying the loan before the term ends.
Seek Out The Right Help Before You Invest
Thanks to the Labor government’s Housing Australia Future Fund, new generations of prospective homebuyers can enjoy secure rental housing before they buy. So current pressures to buy in order to enjoy housing security will likely dissipate over the coming years.
With this extra freedom, first home buyers can expect more fruitful opportunities within the Australian real estate market, ensuring that you can start investing when it feels right for you. And when that time comes, if you consider the options available to you and do your due diligence when selecting both a property as well as a suitable home loan, you should be able to enjoy a fruitful first-time investment in real estate.
Of course, when you do decide to invest in a new home, be sure to consult a financial advisor, your mortgage broker, or other trusted financial service providers to discuss these options. We also recommend using an online mortgage calculator to plug in the numbers representing your specific goals and current financial picture to arrive at the most accurate projection.
So long as you use the tools and resources at your disposal and maintain a strategic approach to your home loan planning, you should be able to secure a loan with an interest rate that aligns with your family’s financial needs.
