Fixed vs Variable Interest Rates: Which Should You Choose?
Choosing between a fixed and variable interest rate is one of the most significant decisions you will make when taking out a loan. Each option has genuine advantages and disadvantages, and the right choice depends on your financial situation, risk appetite and view on where interest rates are heading. This guide compares both rate types, explains the split-loan compromise and helps you decide which approach suits your needs.
- Fixed rates provide repayment certainty but sacrifice flexibility
- Variable rates offer features like offset and unlimited extra repayments but your rate can change
- Split loans let you hedge by fixing part and keeping part variable
- Fixed-rate break costs can be substantial if you exit early
- The best choice depends on your personal circumstances, not market predictions
Comparison at a Glance
| Feature | Fixed Rate | Variable Rate |
|---|---|---|
| Repayment certainty | Repayments locked for the fixed term | Repayments can change at any time |
| Extra repayments | Limited (typically $10K-$20K/year) | Usually unlimited |
| Offset account | Rarely available during fixed period | Commonly available |
| Redraw facility | Usually not available during fixed period | Commonly available |
| Break costs | Can be substantial | None (no fixed term to break) |
| Benefits from rate cuts | No (rate is locked) | Yes (rate may decrease) |
| Risk from rate rises | Protected during fixed term | Exposed to increases |
The Case for Fixed Rates
A fixed rate locks your interest rate for a set period, typically one to five years. During this time, your repayments remain exactly the same regardless of what the Reserve Bank or the lender does with rates.
Fixed rates make sense when:
- You are on a tight budget and need absolute certainty about your repayments
- Interest rates are expected to rise and you want to lock in a lower rate now
- You are a first home buyer and want stability while you adjust to mortgage repayments
- You do not plan to make significant extra repayments
- You will not need to sell or refinance during the fixed term
The downsides:
- If rates fall, you miss out — you are stuck at the higher fixed rate until it expires
- Limited or no access to an offset account means your savings do not reduce your interest charge
- Extra repayment limits mean you cannot aggressively pay down the loan
- Break costs can be enormous if you need to exit early (selling the property, refinancing, etc.)
- At the end of the fixed term, you revert to a variable rate which may be higher than the fixed rate you were paying
The Case for Variable Rates
A variable rate moves up and down over the life of your loan. Changes are driven by the Reserve Bank's cash rate decisions, market funding costs and the lender's own commercial considerations.
Variable rates make sense when:
- You want maximum flexibility — unlimited extra repayments, offset account and redraw
- Interest rates are expected to fall or remain stable
- You might sell or refinance within the next few years
- You have income variability and want to make large lump-sum repayments when cash flow allows
- You maintain a significant balance in an offset account
The downsides:
- Repayments can increase when rates rise, potentially straining your budget
- Uncertainty makes long-term budgeting harder
- Lenders can increase variable rates independently of the RBA
The Split Loan Option
A split loan divides your borrowing into a fixed portion and a variable portion. This "best of both worlds" approach provides partial certainty while retaining some flexibility.
For example, on a $600,000 loan, you might fix $400,000 (67%) to lock in your core repayment certainty, and keep $200,000 (33%) variable to use with an offset account and make unlimited extra repayments. If rates drop, the variable portion benefits. If rates rise, the fixed portion protects you.
Common split ratios include 50/50, 60/40 and 70/30. There is no "correct" split — it depends on how much certainty you want versus how much flexibility you need. Most lenders accommodate split loans at no additional cost.
Understanding Break Costs
Break costs are the biggest risk of fixed rates. They compensate the lender for the interest income they expected to earn for the remainder of the fixed term. The calculation is complex and depends on the difference between your fixed rate and the current wholesale market rate, multiplied by the remaining term and your loan balance.
In a falling rate environment, break costs can be very high. For example, if you fixed at 6.5% for three years and rates drop to 5.0% after one year, the break cost on a $500,000 loan could be $10,000-$15,000. Conversely, if rates have risen since you fixed, break costs are usually minimal or zero.
Fixed vs Variable for Car Loans
Most car loans in Australia are fixed rate by default. This provides certainty over the loan term (typically 3-7 years) and makes budgeting simple. Variable-rate car loans do exist but are less common.
For car loans, fixed rates are generally recommended because the loan term is shorter (3-5 years for most borrowers), the certainty is valuable, and the rate difference between fixed and variable is usually small. Break costs on car loans also tend to be smaller than on home loans because the balances and remaining terms are shorter.
- If you need certainty and will not make large extra repayments: consider fixing
- If you want offset, redraw and the flexibility to pay down fast: consider variable
- If you cannot decide or want to hedge: consider a split loan
- If you might sell or refinance soon: avoid long fixed terms due to break costs
- Always compare the total cost, not just the headline rate
WARNING: This comparison rate is true only for the example given and may not include all fees and charges. Different terms, fees, or other loan amounts might result in a different comparison rate. Comparison rates are based on a secured loan of $30,000 over 5 years for vehicle finance and $50,000 over 5 years for equipment finance, as required under the National Credit Code.