What is the Best Type of Loan to Use?
A common question often asked is the difference between a Fixed loan versus a Variable loan and which is better.
The Reserve Bank changes the interest rates depending on the economic conditions which then forces the Banks to react accordingly.
Over the years, we have seen the loans ebb and change and changes could have a significant effect on your personal circumstances.
So let’s have a look at the 3 types of loans out there and the advantages and disadvantages of each of these loans and when to use them.
Fixed Interest loan
- In a fixed interest loan, the rate you are paying is known and fixed for a period of time, so you know exactly what your monthly repayments will be, thus reducing your risks of interest rates and your repayments going up.
- Any interest rate increases will not affect you for the period you have fixed the loan for, such as 1, 2, 3 or 5 years.
- If interest rates were to come down, then you cannot reduce your interest rates unless you pay a premium to get yourself out of this fixed period.
- You cannot make repayments off your principle until the loan period has expired.
- Over the longer period, if interest rates were trending down, then a fixed rate loan will be more expensive.
When to use a Fixed Rate
- When you want certainty of repayments and treat it as an insurance premium even if it cost you more.
- If the interest rate trend is going up and a fixed rate loan will protect you from increases into the future.
- You do not need to or want to or have the capacity to repay the principle and prefer the certainty of Fixed repayments so you can budget your finances.
Variable Interest Rates
- You can make repayments off your principle thus saving you money in the long term on the Interest you could have paid.
- You run the risk that if the interest rates go up, you will be paying more.
When to Use a Variable Rate
- If you would like to pay off the principle which variable loans will allow you to do.
- if you believe long-term interest rates will be trending downwards.
Mix of Variable and Fixed
You can pay down the variable portion of your loan with the certainty of the interest rates not going up for the fixed portion.
You will still pay more on the fixed portion of the interest rate goes down but at least you will take advantage of the lower interest rate on the variable portion.
When Should You Use a Mix?
When you have a sizable loan and you want some comfort that in an upward trending interest rate environment that your repayments are certain. You are hedging your bet each way.
Note: Over the last 15 to 20 years, one would have been better off not to Fix their interest rates since the long-term trend has been going down.
Many fixed-rate customers were left with higher interest rates when the interest rate came down. In fact, the long-term interest rate has been around 7%. The variable rates are currently below the long-term average.
However, interest rates may have now bottomed and it may be prudent to used Fixed Rate loans or at least a higher weighting on Fixed Rate if you have adopted a Mix of Fixed and Variable.
If you look at the 3 to 5 year Fixed rates will give you an idea what the Banks have forecast the interest rates to do into the future.
In other words, if the 3 to 5 year Fixed Rates are lower than the current Variable rates than the banks are forecasting, that long-term variable rates are coming down.
If the 3 to 5 year Fixed rates are higher than the current variable rates than the banks are forecasting, that the long-term trend is going up.
Disclaimer: please do not rely on this article as advice as no one really knows what will happen to interest rates in the future. Not even the banks themselves. Please get your own financial advice before doing anything as your personal circumstances will determine the best type of loan, and everyone’s circumstances are different and require their own unique solutions.
What is the best type of loan to use for your situation? Contact our Chan & Naylor Finance Team here to know your best options.
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Chan & Naylor Group has nationwide offices in North Sydney, South West Sydney, Sydney, Pymble and Parramatta in New South Wales, Melbourne, Moonee Ponds and Hawthorn in Victoria, Brisbane and Capalaba in Queensland, and East Perth in Western Australia that can assist you with low-interest home loans as well as any business or personal tax enquiry that you may have. Contact us today to know what the best type of loan to use for your specific circumstance.