Variable interest rate
Even if you’ve only dipped a toe into the financial world so far, you’ve probably come across the term ‘variable interest rate’. It’s one of the most popular types of home loan rates and is available on just about any banking product you can think of.
But what is it all about? Mozo has compiled this handy guide to give you the rundown on the facts, features, pros and cons of variable interest rates.
What is a variable interest rate?
Let’s start with the basics: just what is a variable interest rate?
Well, just what it sounds like, essentially. The amount of interest you pay or receive will vary over the life of your loan or account. It might rise or fall, depending on what the market is doing and at what rate the RBA set the official cash rate.
Products with a variable interest rate might not offer the certainty that the alternative of a fixed rate does, but they generally make up for it in increased flexibility on things like extra fees or charges.
Pros of a variable interest rate
- Flexibility. This is especially important on things like your home or car loan, as added flexibility in how and when you repay the loan can make a big difference in the amount of interest you end up paying. For more info on the different options a variable rate offers, head to the ‘features’ section below.
- Loans benefit from drops in the market. Are interest rates on the decline and look like dropping further? It might be time to snap up a variable rate and watch your repayments decline.
- Savings benefit from high interest rates. On the other hand, if interest rates are sky-high and rising, your savings could be too.
Cons of a variable interest rate
- Budgeting may be tricky. Because your interest rate is liable to change, you might end up earning or paying a different amount each month. It may only mean the difference of a few dollars, but if you’re a stickler for a monthly budget, a variable rate might not be your cup of tea.
- Rises in loan repayments. If interest rates rise, you may end up paying more on your loan than you had initially planned for.
- Drops in savings. Although a downward shift in the market won’t make your savings decrease as such, it could mean you’re earning less interest. And every little bit helps, right?
Generally speaking, a variable interest rate product will be a little more flexible in terms of features than the fixed rate alternative. This is especially useful with loans, as you’ll usually get full use of helpful features like extra repayments, redraw facility and an offset account to tailor your payments to suit your budget. You will sometimes have use of these features with a fixed rate loan as well, but there are often fees or limits to how you use them.
If you think you might want to pay off your loan before the end of the set term, a variable interest rate is probably the best option, as you usually won’t be charged a break fee or early repayment penalty, which you often would be on a fixed rate loan.
What happens if interest rates change?
If interest rates change, so will your earnings or repayments on a variable interest rate. While this is not such a big deal when you’re earning interest, it can be make-or-break for your monthly budget when you're making repayments.
With this in mind, it’s a good idea to consider what changing interest rates would do to your repayments and how much give there is in your budget to allow it, before you choose a variable interest rate.
For example, say you have a $500,000 home loan over a 25 year period with a variable interest rate, currently at 3.98%. Your repayments at the moment would be $2,634. But if interest rates rise by 0.50% your repayments could go up to $2,773. Can your budget handle an extra $139 in repayments each month?
To find out what a changing interest rate might mean for your loan, why not plug your details into our handy rate change calculator.
What is a split interest rate?
If you’re not sure you want to commit to a variable rate but don’t want to lock your whole loan into a fixed rate, you might have the option of choosing a split rate loan. This means that part of the interest on your loan will be fixed at a certain rate, while the other part will work on a variable interest rate.
Offering the best of both worlds, with the sense of security that comes from a fixed rate, as well as the flexibility of a variable rate, a split rate loan is a popular choice for home loans.
Start comparing variable interest rates
Ready to start comparing products with a variable interest rate? Make our compare interest rates page your first stop, and from there, you can check out interest rates for a range of different products, from home loans to savings accounts.