Fixed vs variable home loans

Different types of home loan interest rates have pros and cons and can affect how much you pay. The two most common types are fixed and variable rates. But what’s the difference between the two, and how do you choose the one that best suits your needs?

• Variable interest rates increase and decrease over time and typically come with more home loan features to help you save money. 
• Fixed variable rates remain the same until the agreed-upon ‘fixed period’ ends, and usually come with fewer cost-saving features, given that this type of interest rate can already be considered a way to lower your home loan costs.

Fixed rates gained popularity in early 2022 when interest rates began to rise at a historic pace. At one point, fixed interest rates even accounted for 40% of home loan lending in Australia. 

Why is that? Well, fixed rates are useful shields against rising interest rates, like when the Reserve Bank of Australia (RBA) increases the official cash rate.

When borrowers fix their home loan, they anticipate variable rates will rise above the rate they have locked in. In turn, borrowers can continue paying interest at a lower rate until their fixed period ends. Fixed rate terms typically last between 1 to 5 years. 

When lenders decide what fixed rates to offer borrowers, they factor in when and where they expect the cash rate to move. 

Generally speaking, if a lender expects the cash rate to rise, its fixed rates will usually be higher than its variable rates. Conversely, if a lender expects the cash rate to fall, its fixed rates will usually be lower than its variable rates. 

Pros and cons of fixed rates 

Fixed rate home loans are famed for their ability to shield against rate hikes and the consistency they offer. 

However, they’re usually light on features like offset accounts and redraw facilities and may have fees for making extra repayments or breaking your fixed rate early. 

You also need to consider the possibility of missing out on falling interest rates when the cash rate comes down. 

Pros

• Repayments stay the same if the cash rate rises 
• Consistent repayments can help you budget more effectively. 

Cons

• Miss out on falling interest rates if the cash rate drops
• Typically lacks interest-saving features (e.g. offset accounts) 
• Limits or fees placed on extra repayments
• Penalises early payouts and breaking fixed terms early.

Variable interest rates tend to move broadly in line with the RBA’s cash rate and reflect the state of the economy. 

When inflation rises, the RBA attempts to slow it down by raising the cash rate. This usually increases home loan interest rates for borrowers. 

On the other hand, when the economy needs people to spend money, the RBA will cut the cash rate, as we saw during the Covid-19 pandemic. In effect, this reduces home loan interest rates.

For instance, the average variable rate back in May 2022, when the first cash rate hike in the RBA’s latest tightening cycle happened, was 3.02% p.a. After 13 cash rate hikes, the average variable rate now sits at 6.8% p.a.†

Pros and cons of variable rates

Variable rate home loans have flexible interest rates, which can be a good thing or a bad thing, depending on what happens with the cash rate and the economy more broadly. 

There are usually more interest-saving features available with variable home loans (e.g. offset accounts, unlimited free extra repayments, and redraw facilities), which can help you to reduce costs and pay off your home loan faster – just make sure you check if there are fees involved. 

However, variable rates are especially susceptible to interest rate rises, which may mean your rate increases dramatically, depending on how the RBA’s cash rate tracks. 

Pros

• Typically come with interest-saving features like offset accounts and redraw facilities
• More flexibility to make free additional repayments 
• Usually easier to refinance than fixed rates
• Benefit from rate reductions if the RBA cuts the cash rate.  

Cons

• Disadvantaged by cash rate increases 
• Extra features can sometimes increase the interest rate or mean extra fees.

Say, you’re a borrower with an average mortgage size of $626,000 and have a home loan term of 25 years. 

The graph below looks at a hypothetical 5-year home loan scenario, pitting a fixed rate against a changing variable rate. 

The red, orange, light blue and green lines show the variable interest rate starting at 6% p.a. and increasing or decreasing by different amounts, while the dark blue line in the centre shows the fixed interest rate at 6.5% p.a. 

If the borrower considers fixing initially for five years at 6.5% p.a. (dark blue line) and the variable rate doesn’t change from 6% p.a. during that fixed term (light blue line) then, the borrower would pay an extra $11,600 in repayments over five years.

But if you decided to fix your home loan for 5 years from the start, and variable rates rose in a straight line (red) from 6% p.a. to 8% p.a., it would save you almost $12,100.  

On the other hand, choosing to fix your rate for 5 years and watching variable rates drop by 1% (green line) would end up costing you an extra $22,900.

Of course, this is purely a hypothetical situation. Variable interest rates go up and down all the time – it’s their defining characteristic.

This may mean you’re stuck paying slightly more interest on a fixed rate for a few years, or it could be the case that you fixed right before variable rates skyrocketed. 

That’s why it’s important not to caught up in a ‘shoulda, woulda, coulda’ mentality with your home loan rate. Instead, consider your personal circumstances and goals, and do what suits you best at the time. 

It’s hard to predict whether interest rates will rise or fall at any given time – even the in-house economists at the Big Four banks are split on when interest rates will come down. 

So, the best way to decide on between fixed or variable is to arm yourself with the latest news on interest rates and consider what you can reasonably afford to pay.   

Using a home loan rate change calculator, you can work out how much extra you’ll need to pay if, for instance, your interest rate goes up by 0.25%. 

But more generally, variable rates suit borrowers who want flexibility, while fixed rates suit those who prefer the consistency of fixed repayment amounts.  

To see what interest rates lenders are currently offering, compare home loans today. 

†Average rates based on a 25-year, owner-occupied, variable or fixed home loan at $400,000, for a borrower making principal and interest repayments with 80% LVR, as at 12 July 2024.