What is a fixed rate home loan?

Fixed or floating what’s the right type of home loan for you? Before making that decision it can be useful to first take a step back and ask: what is a fixed-rate home loan?

What is a fixed rate home loan?

A fixed rate is just that: static. Essentially, a fixed rate home loan means your loan repayments will be charged at the same interest rate for however long the fixed rate period is. This rate is commonly for a period between 1 – 5 years. After this period, the rate will revert to a floating rate, unless you enter into another fixed-term contract.

Historically, fixed rate loans have been more popular in New Zealand, although the proportion of fixed to floating loans does vary over time.

And the good news is that at the moment, whether you choose fixed or floating, current average home loan interest rates are a far cry from their peak of 20.5% in June 1987!

In theory, fixed-rate home loans have priced any predicted short/medium-term rises and falls in the official cash rate into their fixed interest rate. As such, when institutions are expecting future falls in the official cash rate, their fixed rate loan offerings may be priced more cheaply than their variable rates. On the other hand, when institutions are expecting a lift in economic conditions (and hence the official cash rate), their fixed-rate loan pricing will likely reflect this outlook.

kiwi-bank-awardKiwibank: Interest rates expected to remain steady

Pros and cons of a fixed rate home loan

Locking in the interest rate on your home loan provides certainty in terms of your monthly repayment. This can make budgeting much easier, particularly in the first few years of home ownership. Your fixed rate will protect you in the short term against any increases in the official cash rate.

On the flip side, a potential disadvantage of fixed rate loans is that if interest rates fall, your ability to realize those savings will be delayed.

Another disadvantage of a fixed rate home loan is inflexibility. If you wish to end your fixed contract (perhaps due to selling your property and moving), you may have to pay a break fee. Depending on interest rate movements in the time since you started your contract, this could be expensive.

If you’re considering a fixed rate home loan, be sure to do your research and thoroughly compare fixed and variable rate loans before making a decision. You can compare current fixed rate home loans on CANSTAR’s database here.

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