Interest Rate Types

Fixed Interest Rate Mortgages The interest rate you pay is fixed for a period from six months to five years. At the end of the term, a fixed-interest loan automatically moves to a floating rate unless you negotiate another fixed term.

Advantages:

  • You know exactly how much each repayment will be over the term.
  • Fixed rates are often lower than floating rates, as lenders compete with fixed-rate specials. A one percentage point difference in interest rates can save you thousands of dollars, even within a year or two.
  • You can lock in lower rates if market interest rates are rising.

Disadvantages:

  • Fixed rates often have limits on how much you can lift repayments or make lump sum payments without incurring charges.
  • If you fix over a longer term, there is a risk floating rates may drop below your fixed rate.  

Capped Interest Rate Mortgages

Capped rates are a variation where the interest rate cannot rise, but will drop if floating rates drop below the capped rate.

Floating/Variable Rate Mortgages

Lenders of floating-rate loans will lift or lower the interest rate as interest rates in the wider market change. This means your repayments may go up or down.

Advantages:

  • You can usually lift your repayments or make lump sum repayments without penalty.
  • It is easier to consolidate other costlier debt into floating rate loans by borrowing more.

Disadvantages:

  • Floating rates have often been higher than fixed rates.
  • When rates go up the repayments also go up, putting a squeeze on your budget.

A Mix of both

It is possible to split a loan between fixed and floating rates. This lets you make extra repayments without charge on the floating rate portion while you get lower rates on the fixed portion.

How you split your loan is important and can be worked out by considering the total extra cash you're likely to get from work bonuses or the like during the period in which you've set the fixed rate. This is the amount you could put on a floating rate.

When the fixed rate part of your loan comes up for renewal, if you've paid off some or all of the floating part, you'll need to repeat the exercise for the next year or two.