Want me to tell you whether you should fix your rate?
Let’s start with the main differences between a fixed and variable interest rate.
Fixed Rate – the interest rate and therefore the repayments will not change during the contracted fixed rate period. This is usually 1 to 5 years but some lenders offer much longer. That means you have certainly during the period as to what you will be repaying. There are some down sides though.
You may be surprised to learn that most lenders provide a way around some of the downsides. It comes in the form of a split loan – more on that in a minute.
Variable Rate – The interest rate will vary, generally but not always in line with the Reserve Bank’s official interest rate. Your repayments can also increase if the interest rate increases. I say ‘can’ rather than ‘will’ because it does depend on your individual circumstances. Mostly though, you will be asked by your lender to increase your monthly repayments if the rate increases.
Of course, if the interest rate is reduced, you will enjoy the benefit where some one on a fixed rate won’t.
Note that a lender will not generally reduce your repayments if the rate reduces. It means that a larger portion of what you are paying goes toward paying off the loan rather than paying interest.
Split Loan – You are able to split your home loan into a Fixed Rate portion and a Variable Rate portion. You might choose to do this if you aren’t sure which way future interest rates might go and want an element of certainty with the opportunity to take some advantage if rates fall.
The major advantage, I believe, is being able to take advantage of a fixed rate for, say 80% of your loan, leaving 20% variable so that you can make extra repayments and redraw if necessary.
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Firstly, what is an Interest only loan? This is a loan option in which you pay only the monthly interest. The result of course is that you do not pay anything off the principle, so the amount you borrowed never reduces.
Why would you do that? For most people paying of a home loan is their goal. Under some circumstances that is exactly why you would take out an interest only loan.
Imagine you had a loan on your home. I know, many of us don’t have to imagine, it’s reality. You live in it and are paying Principle and Interest so that one day you will pay it off and be debt free. Wouldn’t that be a great feeling!
At some point you may decide to purchase an investment property. It can be a great way to use the equity you have accumulated in your home through paying down the loan and rising property values with the aim of building wealth.
So here’s the interesting part. Interest on an investment property is tax deductable. Interest on your owner occupied home loan isn’t.
You could be better off paying your non-deductible owner occupied home loan more quickly and leaving the investment debt for now.
You can achieve this by taking an Interest Only loan over the investment property and use the extra that you would have paid off the principle to pay off your owner occupied, non-deductible home loan more quickly.
This can be an effective strategy BUT you need to have the discipline to pay the extra off the non-deductible loan. It really doesn’t help if you spend the money elsewhere.
This isn’t for everyone and definitely depends on your circumstances. If you are considering an Interest Only, or any home loan, talk to a Credit Advisor/ Mortgage Broker first. They may suggest involving other professionals such as your accountant.
It is a big decision involving a lot of money, you want someone who can help you get it right.
John Gill is a Mortgage Broker and a member of the Mortgage and Finance Association of Australia (MFAA). He holds a Diploma of Finance and Mortgage Broking Management and is a member of the Credit Ombudsman Service limited. John is also a member of AFG – the Australian Finance Group Limited, one of the largest broker groups in Australia.
John is the owner and director of Mortgage Scope Pty Ltd, the Home Loan Specialists.
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