Fixed Rate Home Loans: Pros, cons & what happens if you repay some or all of it early
Fixed rate home loans are designed to give you interest rate and repayment certainty for a term of up to 10 years. The benefit of a fixed rate loan is that you will know exactly how much your repayments will be and how much interest you’ll pay. A fixed rate loan will also protect you from any interest rate rises that occur during your fixed term period, but there are also downsides.
You wont be able to enjoy interest rate decreases
During the fixed term of your loan you are protected from interest rate rises, but wont be able to enjoy the benefits of any interest rate decreases that occur in the market without breaking your fixed rate loan and moving onto a variable interest loan.
You wont be able to enjoy interest rate decreases
Fixed rate loans generally have less flexibility and offer less features such the ability to operate an offset account, make additional repayments or take repayment holidays.
You may have to pay an early repayment fee
When choosing a fixed rate loan you need to know that if you repay the loan (either in full or in part) or switch to another fixed or variable interest rate loan before the end of your fixed rate term, then you may have to pay an early repayment fee.
Why do fixed rate loans have an early repayment fee?
Fixed rate loans are a contract between you and your lender. They give you certainty about your repayments and provide your lender with certainty about the interest they will receive over your fixed rate term. When you payout your loan before the end of the fixed term, then you are breaking your contract with your lender, for which they will charge you a fee to compensate them for the loss of not earning interest on the remaining term of your fixed loan.
How is the early repayment fee calculated?
The cost isn’t the same for everyone – it’s based on a calculation that takes into account things like:
Whether you are paying off the whole loan, or part of it
Whether you are switching to another fixed or variable interest rate loan with the same lender
The time left of your fixed rate loan term
The difference between wholesale lending interest rates when your loan started, to when your loan is paid out
Wholesale lending interest rates are the interest rates the lender is paying on acquiring the funds that they then subsequently lend to you. These rates, like normal interest rates can change daily, and are influenced by more than just the rate set by the Royal Bank of Australia.
How to estimate your early repayment costs
The below table provides an estimate on early repayment fees, based on the length of time remaining on your fixed loan, and the changes in wholesale interest rates. The figures provided are per $100,000 of loan amount.
*Difference in rate is calculated as being the wholesale interest rate on the day your fixed interest loan started minus the wholesale interest rate on the day your loan is paid out.
Example of how to calculate early repayment fees
Amanda takes out a 3 year fixed interest loan for $200,000, when wholesale interest rates are 7%. 12 months later she decides to pay out the loan. At this time, the wholesale interest rate is 5% (the difference is therefore 2%) & she has 2 years left on her fixed interest loan term.
From the table we can see that for every $100,000 on loan amount Amanda will incur an early repayment fee of approximately $3,838, making her total early repayment fee approximately $7,676.
Are early repayment fees applicable when I make extra repayments on my loan?
Each lender will have different policies about whether you can make extra repayments on your fixed interest loan and what fees, if any are involved with doing so. For any loan we recommend to you, we will ensure you have all this information up front, so you can make an informed choice about the best option for you.
What other options are available?
If you’re thinking of applying for a fixed rate loan, you need to be sure it’s the right loan for you, as the early repayment fees can be significant. If you think you may be able to make additional repayments, pay your loan off relatively quickly, or wish to take advantage of any interest rate decreases that occur in the market in the short to medium term future, then you may wish to consider:
Selecting an appropriate term for your fixed rate home loan. For example, if you prefer the certainty of a fixed rate, but know you will be selling the property in 12 months time, then a 12 month fixed rate term is an appropriate term for your situation.
Splitting your loan into 2 parts, a fixed rate portion, which provides certainty for repayments, and a variable rate portion, which provided flexibility and lets you enjoy the benefits of lower interest rates if they come. If you do decide to pay out the loan during your fixed period, the early repayment fees are only calculated on the fixed portion of your loan, not your whole loan.
Selecting a variable rate home loan will provide maximum flexibility and wont attract early repayment fees.
If you have any questions regarding any of the information provided above, or would like to speak to one of our brokers about your home loan, please contact us on (08) 8224 0044.
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