It can be confusing, particularly when you’re new to the home loan market, to understand just what the difference is between different types of loans. What sort of home loan features will you need? What size loan? Will you be able to afford the monthly repayments? We have articles that cover all those questions, but let’s take a step back first and answer a basic question: what is a floating rate home loan?
What is a floating rate home loan?
At its core, a floating rate home loan is what it says: a home loan on which the interest that is charged can fluctuate at any time. Any change generally mirrors changes in the RBNZ official cash rate, changes in market interest rates, or may simply be a business decision by your financial institution.
In terms of your home loan repayments, a floating rate loan means that the monthly loan payments will change to match any change in the interest rate applied. Here’s an example of the difference a changing interest rate can make to the monthly repayments of a $400,000 home loan on a 25 year term:
|Home loan||Monthly repayment @ 5.5%||Monthly repayment @ 6%||Monthly repayment @ 6.5%|
General example only. Figures should not be relied on for your personal situation.
What difference could a fluctuating interest rate make to your home loan? Play around with our mortgage calculator to find out.
Floating rate home loans are far more instantly responsive to changes in the official cash rate than fixed-rate loans are. Generally, when the official cash rate falls, you should expect the interest rate on your variable rate home loan to fall soon afterwards; when the official cash rate increases, you should expect an increase in the interest rate on your home loan almost straight away.
Fixed-rate home loans, on the other hand, have theoretically already priced short-term predicted rises and falls in the official cash rate into their fixed interest rate, so should not be as quickly responsive to RBNZ cash rate decisions.
Pros and cons of floating rate home loans
The main advantage of a floating rate loan is flexibility. While you must meet your minimum monthly repayment, you can usually pay more if you want to. There is also no cost penalty if you decide to sell your property and move.
The main disadvantage of a floating rate loan is that your minimum repayment amount may rise or fall at any time. If you are on a tight budget, this could be a real problem for you.
If you’re considering a floating rate home loan, be sure to do your research and thoroughly compare fixed and variable rate loans before making a decision. Click here to compare home loan interest rates on our database.