You've heard of them before but what are they? Let's look at it!
Fixed and Floating interest rates are two different types of interest rates that can be chosen when obtaining a mortgage. In this article we will highlight the difference between the two structures and the pros and cons of each type.
Fixed Interest Rate
If you go to any banks website and go to their mortgage section - you will see 6-months, 1-year, 18-months, 2-years, 3-years, 4-years and 5-years interest rates. These are fixed interest rates. For example, lets say the 1-year rate is 6.5%. This means that you have committed to 6.5% on your Mortgage for 1-year. As a result, your mortgage repayments will remain constant over the 1-year period. At the end of the fixed period, you can have the option to renew the fixed rate or change it to a floating rate or refinance.
Pros:
Stability, predictability and certainty:
Your mortgage repayments will remain the same over the fixed period. This makes it easier to budget.
If bank interest rates interest increase, you will not be affected by it during the fixed period.
Cons:
In-flexible:
If interest rates start falling and you want to change interest rates/ refinance during the fixed term - you will have to pay break-fees which can be expensive.
You cannot make lump sum payments or make early repayments without incurring a penalty.
Floating Interest Rate
The floating rate fluctuates with the market - namely the OCR (Official Cash Rate) set by the reserve bank (plus a margin). This means mortgage repayments will fluctuate with the OCR. The floating rate is typically higher than fixed rates but offers much more flexibility. Your bank will notify you every time the floating rate changes. Floating / Variable rate is also the rate used for Revolving Credit/ Offset mortgage accounts which can help pay down your mortgage faster and save thousands of dollars on interest payments if used correctly.
Pros:
Flexibility:
You can make lump sum or extra repayments anytime without incurring penalties.
No break fees if you want to refinance your mortgage.
When interest rates fall, your minimum mortgage repayments decrease.
When used with a Revolving Credit/ Offset account - you can pay down your mortgage faster and save thousands of dollars on interest payments.
Cons:
Unpredictable:
Since your mortgage repayment is dependent on changes in OCR - this isn’t great for budgeting or certainty.
If interest rates climb, so will your mortgage repayments, which can lead to affordability issues.
Floating rates tend to be higher than fixed rates.
Can you split your mortgage and use a combination of fixed and floating?
There is no requirement to have your entire mortgage on fixed or floating rates. You can mix it up if you like. You can choose to split your mortgage amounts and have them on different fixed rate periods.
For example:
Say your Mortgage is $600,000. You can split this as follows:
$200,000 fixed for 1-year
$150,000 fixed for 2-years
$200,000 fixed of 3-years
$50,000 in revolving credit/ offset account at the floating rate.
Splitting your mortgage into different portions with different rates is known as interest rate averaging.
Bottom line?
How you decide to structure your mortgage will depend on your circumstances, capability and goals. This is where a Mortgage Adviser (aka Mortgage Broker) can give you appropriate advice. If you would like more guidance, feel free to contact us.
Disclaimer
The contents of this article are for information-only and may express the opinion of the writer. This article is not be taken as personalised financial advice, as everyone’s situation is different. Please always seek advice from a financial adviser before making any decisions with your personal and/or business finances.
