Variable Rate Home Loans

Variable rate home loans are one of two broad product categories offered by home loan lenders. Fixed rate home loans are the other. It is important for borrowers to understand the fundamental differences between these two types of home loans and the comparative advantages and disadvantages of each.

What are variable rate home loans?

The interest rate on a variable home loan moves up or down based on market conditions. A fixed home loan interest rate on the other hand stays the same for a defined period of time, usually 1-5 years.

It’s possible for variable home loan rates to be higher or lower than the fixed interest ones that are on offer from lenders in the market. For example, if fixed rates are lower, it’s a sign that lenders believe that the variable rates will fall further in the future, and vice versa.

It is important to be aware that two home loan interest rates are typically advertised on a home loan product: nominal and comparison. The comparison is the higher of the two and provides the total cost. It includes both interest and all associated fees/charges.

Under the National Credit Code in Australia, lenders are legally required to provide borrowers with the comparison interest rate on their products. This allows borrowers to accurately compare the actual total costs.

Types of variable rate home loans

There are four basic types:

Basic
Full-featured
Package
Introductory.

Basic variable home loans

This product has very few additional features for borrowers. It is sometimes referred to as a ‘no-frills’ loan and usually has a slightly lower interest rate than other variable options.

Full-featured variable home loans

This is the most common type of home loan product in the Australian market. It is often referred to as a ‘standard’ variable loan. It comes with arrange of additional features for borrowers, such as:

The ability to make extra repayments.
Access to a redraw facility. A redraw facility allows borrowers to withdraw the extra repayments they've made on their home loan.
Access to an offset account. This allows a borrower to offset the balance of the deposit funds that they have in a separate offset account with the lender against their outstanding home loan balance. For example, if a borrower has a home loan balance of $200,000 and $10,000 in an offset account, they would only be charged interest on $190,000 (instead of $200,000).
The option to split the loan into variable and fixed components. The variable interest rate is applied to part of the balance and a fixed to the remainder. The borrower can usually decide the split proportions (e.g. 50/50, 60/40, 70/30 etc.). A split home loan provides borrowers with some flexibility and some security if interest rates fluctuate.

Variable package home loans

This option combines a borrower’s home loan with other financial products (such as credit cards, an everyday transaction account and insurance cover) into one ‘bundle’.

The lender will often charge a lower nominal interest rate on this bundled package, but they may charge an annual fee (as opposed to charging the borrower multiple fees if their financial products were separate). As mentioned earlier, borrowers should always use the comparison rate to determine the true cost of any loan (i.e. the total cost plus all associated fees and charges).

Introductory home loans

Some lenders offer introductory ‘honeymoon’ periods where they provide a discount on their variable interest rate to borrowers for a short time period (usually 12 months, but it can for periods as short as six months or up to three years). At the end of the introductory period, the lender’s standard variable rate then applies.

It may be worth to check the comparison rate on introductory loans to ensure the borrower is aware the rate it will revert to after the introductory period.

The pros and cons of variable rate loans

Variable home loans have both advantages and disadvantages, just as fixed products do. Whether they’re a good option depends on:

The borrower’s personal financial circumstances.
Future interest rate movements, which are influenced by changing economic conditions.

Advantages of a variable home loan

If interest rates go down, variable borrowers will be paying less interest than those with a fixed rate for the same amount.
Full-featured variable home loans provide borrowers with a range of potentially useful additional features that fixed products don’t.
Variable home loans usually have lower fees than fixed products.
If variable borrowers want to change to switch to a fixed interest product at any stage, there are no ‘loan break’ fees involved (as there often is when switching the other way, i.e. from a fixed product to variable).

Disadvantages of a variable home loan

If interest rates go up, a variable borrower will be paying more interest than a borrower with a fixed product for the same loan amount. The borrower’s repayments will also increase accordingly.
There is more chance for borrowers to get themselves into home loan stress. Home loan stress is defined as the situation where a household does not have enough income to cover all their living expenses as well as their home loan payments. Household debt in Australia is currently at record levels. Even a small rise in interest rates and the associated home loan repayments could place many households in home loan stress.
Fixed borrowers can budget for the future with more confidence than variable home loan borrowers because they know exactly what their repayments will be for a set period. This can be especially useful at certain times of life (for example, when borrowers are starting a family).

What to look for in a variable rate home loan

The most important things for borrowers to look for when evaluating variable options are:

They type of variable home loan product that best meets their needs.
The comparison interest rate between different types of products.
The accompanying features and their associated fees. It’s important for borrowers to only choose and pay for features that they need and will actually use.

The bottom line

Taking out a home loan is a major financial decision. The market is highly competitive and there is a vast range of products on offer. It is worthwhile for borrowers to seek professional advice to secure the most appropriate option for their individual circumstances.

If you’re interested in a variable rate home loan book an appointment to speak with one of our home loan specialists. Or start to compare home loans online.