With most types of home loans you can choose either a fixed or a floating (or variable) interest rate.
Some people will split the amount they borrow between two loans, one with a fixed interest rate and the other with a floating rate.
Revolving credit home loans and offsetting home loans have a floating interest rate.
Fixed interest rate
A fixed interest rate will not change during the period (term) of the fixed rate that you choose. At the end of your fixed interest rate term you can either choose a new one from the rates available at that time, or move to a floating interest rate.
Pros and cons
- You can’t be affected by interest rate increases, so you have the certainty of knowing exactly how much each repayment will be during the fixed term.
- Fixed rates can be lower than the floating rates.
- If the floating rate falls below your fixed rate during the fixed term, you continue to pay the fixed rate.
- You might have to pay an early repayment charge if you want to make extra repayments or pay off the loan faster than initially discussed at the start of a fixed interest rate term.
How to choose the length of your term
- If certainty and security are important to you, or you believe interest rates may go up during the term, then choose a longer term loan.
- If you believe interest rates may go down in the short term, or if you expect to sell your house in the near future, then choose a shorter term loan.
Floating interest rate
A floating interest rate may go up or down as interest rates in the wider market change. You can change to a fixed interest rate at any time, although some types of loans are only available with a floating interest rate.
Pros and cons
- You have the flexibility to make lump sum repayments of any size at any time without penalty.
- If interest rates go down, you can potentially pay off your loan faster by keeping your repayments at the same level.
- As the rate is floating it can go higher than fixed term rates.
- If the interest rate goes up, so will your repayments which could put a squeeze on your budget.
To help you understand the differences between the interest rate options in a Home Loan, I have put a list of the most frequently asked questions below.
Frequently Asked Questions
What is a Fixed Home Loan?
A fixed interest rate Home Loan fixes the interest rate for however long the mortgage term is for. In most cases, this will be between 6 months and 5 years. During this time the Home Loan repayment remains the same throughout the term, as the interest rate is agreed upfront and will not change even if interest rates in the market move up or down.
What is a Floating Home Loan (also know as Variable)?
- The interest rate moves up or down with the market – if interest rates increase, you will pay a higher Home Loan repayment, and if interest rates decrease, you will pay a lower Home Loan repayment. This can complicate budgeting as there is no certainty around the interest rate or your repayment amount.
- The current floating interest rate offered will usually be higher than current fixed-rate home loan offers – you will usually see the floating rate around 1% higher than the fixed interest offers.
- The home loan has no contracted term – in most cases you can switch to a fixed rate home loan without any penalty.
- You won’t be penalised if you overpay – unlike fixed rate home loans, you can make additional repayments to bring down your home loan and you won’t be charged any penalties.
What are the advantages of a fixed rate Home Loan?
If you are able to get a lower interest rate than your existing deal, switching to a fixed interest rate on your home loan will most likely save you money with every payment.
The top reasons to switch to a fixed interest rate are:
- To pay less every month with a lower interest rate. Lowering your home loan’s interest rate can reduce your monthly payment if the repayment term (duration) remains the same.
- There are suggestions in the media that interest rates will rise/fall. By fixing an interest rate, you can be protected from interest rate movements from 6 months to 5 years. Be cautious of “media commentary” as no one can predict exactly what movements in interest rates will be in the future.
- To provide certainty in your budget. A fixed interest rate home loan gives you certainty and may save you money overall depending on what happens with interest rates.
Can a fixed rate home loan increase?
No – for the term of the mortgage, be it 6 months, 1 year or even 5 years, you will pay the agreed interest rate. It’s only after that term that you will pay the floating rate, which could be higher or lower than the fixed interest rate you originally signed up for.
Can a floating home loan rate decrease?
Yes – the Reserve Bank of New Zealand can drop the government interest rate at any time if there is an economic need, meaning banks will drop their interest rates. Also, competition among banks may mean that your current home loan is less competitive than another banks’ offer.
How do you calculate fixed home loan payments?
The longer the term of the loan, the lower the monthly home loan payment will be, but you will pay more interest overall. This mortgage calculator gives you a weekly, monthly and annual home loan payment estimate.
Is a fixed rate home loan better than a variable?
It depends. If you want the certainty of fixed mortgage payments, then a fixed rate home loan could be the best option. Alternatively, if you believe interest rates will fall and want to fix at a lower rate than what is currently being offered, a variable interest rate may be a good idea.