Fixed vs Variable Interest Rates

Interest is the cost of borrowing money, expressed as a percentage of the outstanding loan balance. When you take out a home loan, the interest rate is the single biggest factor determining how much you will pay over the life of the loan. Even a small difference in rate — say 0.25% — can translate to tens of thousands of dollars over a 25-to-30-year loan term.

Home loan interest rates are influenced primarily by the central bank in your country — for example, the Reserve Bank of Australia (RBA) in Australia, the Federal Reserve in the USA, the Bank of England in the UK, the Bank of Canada in Canada, or the Reserve Bank of New Zealand (RBNZ) in New Zealand. The central bank sets a benchmark rate (often called the cash rate, base rate, or federal funds rate) that flows through to the rates lenders offer consumers. When the central bank raises this rate, variable mortgage rates typically increase by a similar amount shortly after. When it cuts, variable rates usually come down — though lenders do not always pass on the full cut.

Beyond the cash rate, lenders set their rates based on their own funding costs, competitive positioning, and the level of risk associated with different borrowers. This is why you will see a wide range of rates advertised across different lenders — the difference between the highest and lowest variable rates on the market can be 1% or more at any given time.

Understanding how rates work is the foundation for choosing between fixed and variable — the two fundamental rate structures available to home loan borrowers worldwide. Each has distinct advantages and disadvantages, and the right choice depends on your financial situation, risk tolerance, and outlook for the economy.

A fixed rate home loan locks in your interest rate for a set period — typically one to five years, although some lenders offer terms up to ten years (and in the USA, 15-year and 30-year fixed terms are common). During the fixed period, your repayments remain exactly the same regardless of what happens to the central bank rate or variable rates in the market. This certainty is the primary appeal of fixing.

The main advantage of a fixed rate is budget certainty. You know exactly what your repayments will be for the duration of the fixed term, which makes financial planning much simpler. This is particularly valuable for buyers on a tight budget where even a small increase in repayments could cause financial stress. If rates rise during your fixed period, you are protected — you continue paying the lower locked-in rate.

However, fixing your rate comes with significant trade-offs. If rates fall during your fixed period, you miss out on the savings. You are locked into the higher rate and cannot simply switch. Fixed rate loans also typically have restrictions on extra repayments — most lenders cap additional repayments at $10,000 to $20,000 per year during the fixed period. And if you need to break the fixed rate early (for example, to sell the property or refinance), you may face substantial break costs.

Fixed rate loans also typically do not offer features like an offset account or redraw facility, although some lenders now offer "basic" offset on fixed loans. If you have significant cash savings that you want to offset against your loan balance, a variable or split loan may be more suitable.

A variable rate home loan means your interest rate can change at any time. The rate typically moves in response to central bank rate decisions, but your lender can also adjust the rate independently based on their own funding costs and competitive strategy. This means your repayments can go up or down over the life of the loan.

The biggest advantage of a variable rate is flexibility. Most variable loans allow unlimited extra repayments with no penalties, and they typically come with features like offset accounts and redraw facilities that can save you significant interest over time. An offset account is a transaction account linked to your loan — the balance in the offset account is deducted from your loan balance when calculating interest. If you have $50,000 in offset against a $500,000 loan, you only pay interest on $450,000.

Variable rates also tend to be more competitive than fixed rates during periods when the market expects rates to remain stable or fall. Lenders compete aggressively for variable rate borrowers, and you can often negotiate a lower rate simply by calling your lender and asking — or by threatening to refinance. This leverage does not exist with fixed rate loans.

The downside of a variable rate is uncertainty. When the central bank raises its benchmark rate, your repayments increase — and during a tightening cycle, rates can rise rapidly. In 2022 and 2023, central banks around the world — including in Australia, the USA, UK, Canada, and New Zealand — raised rates aggressively, adding hundreds of dollars per month to variable rate mortgage repayments. Borrowers on fixed rates were shielded during this period, while variable rate borrowers bore the full impact.

If you are on a variable rate, maintaining a financial buffer is essential. Aim to have at least three to six months of repayments saved in your offset account or a separate emergency fund to cushion the impact of unexpected rate rises.

If you cannot decide between fixed and variable, a split rate loan offers a middle ground. With a split loan, you divide your total borrowing into two portions — one fixed and one variable. This allows you to benefit from the certainty of a fixed rate on part of your loan while retaining the flexibility of a variable rate on the remainder.

The split ratio is up to you. A common approach is 50/50, but you can adjust the weighting based on your priorities. If you value certainty, you might fix 70% and leave 30% variable. If you want maximum flexibility and just a small hedge against rate rises, you might fix only 30% and leave 70% variable.

The main benefit of a split loan is risk management. If rates rise, the fixed portion shields you from part of the increase. If rates fall, the variable portion allows you to benefit from at least some of the decrease. You also retain access to offset and redraw on the variable portion, giving you tools to reduce interest and access funds when needed.

The downside is complexity. You are managing two loan accounts with different rates, repayment schedules, and features. You also face the same break cost risk on the fixed portion if you need to refinance or sell before the fixed term expires. But for many borrowers, the peace of mind and strategic flexibility make the split approach well worth the minor administrative overhead.

Choosing to fix your rate is essentially a bet that rates will rise — or at least stay at similar levels — during your fixed period. But beyond market predictions, there are personal financial reasons that might make fixing the right choice for you regardless of the rate outlook.

Fixing makes the most sense when you have a tight budget and cannot absorb higher repayments. If a 1-2% rate increase would put you under financial stress, the certainty of a fixed rate provides essential protection. It also suits borrowers who prefer simplicity and do not want to monitor rate movements or worry about the impact of central bank decisions on their household budget.

Fixed rates are also attractive when the gap between fixed and variable rates is small or when fixed rates are lower than variable rates. This unusual situation sometimes occurs when the market expects the central bank to cut rates in the near future — lenders price this expectation into their fixed rates, making them temporarily cheaper than variable. When this happens, it can be an excellent time to lock in.

• You are on a tight budget and cannot afford any increase in repayments
• You are about to go on parental leave or expect a temporary income reduction
• Fixed rates are currently lower than or comparable to variable rates
• You do not plan to make significant extra repayments during the fixed period
• You have no plans to sell, refinance, or restructure within the fixed term

If you do decide to fix, shorter terms (one to two years) offer more flexibility than longer terms, as the break costs are lower and you can reassess sooner. Many borrowers use a "rolling fix" strategy — fixing for one or two years, then reassessing and either fixing again or switching to variable based on the conditions at that time.

Variable rates suit borrowers who prioritise flexibility and are comfortable with some degree of payment uncertainty. If you are in a strong financial position with a healthy buffer, the advantages of a variable rate — unlimited extra repayments, offset accounts, and the ability to refinance without break costs — make it the default choice for many borrowers.

If you have significant cash savings, a variable loan with a full offset account is particularly powerful. By parking your savings in the offset, you reduce the interest charged on your loan without locking the money away. You can still access the funds at any time for emergencies or opportunities. On a $500,000 loan at 6%, keeping $100,000 in offset saves you $6,000 per year in interest — and reduces the life of your loan by several years.

Variable rates are also the better choice if you plan to make aggressive extra repayments. Paying an extra $500 per month on a $500,000 variable loan at 6% over 30 years would save you approximately $170,000 in interest and shorten your loan by about 8 years. Fixed rate loans typically cap extra repayments, limiting your ability to pursue this strategy.

Finally, if you think there is any chance you will need to sell, refinance, or significantly change your loan structure within the next few years, a variable rate avoids the risk of break costs. Life changes — new jobs, relationships, family circumstances — are hard to predict, and variable rates give you the freedom to adapt.

A rate lock (also called a rate guarantee) is a feature offered by some lenders that allows you to secure a fixed rate at the time of application, protecting you from any rate increases that occur between application and settlement. This is particularly useful when purchasing off-the-plan or when settlement is several months away.

Without a rate lock, the fixed rate that applies to your loan is determined at the time of settlement — not at the time you apply. If rates rise between application and settlement, you could end up paying a higher rate than you expected. A rate lock removes this uncertainty by guaranteeing the rate advertised when you applied.

Rate locks typically come with a fee, usually ranging from $500 to $750, and they last for a defined period — commonly 60 to 90 days. If settlement occurs within the rate lock period, you receive the locked rate. If settlement is delayed beyond the lock period, the lock may expire and you could be subject to the prevailing rate at that time.

Whether a rate lock is worth the fee depends on the rate environment and the time between your application and settlement. If settlement is only a few weeks away and rates appear stable, it may not be worth the cost. But if you are buying off-the-plan with a settlement date months away in a rising rate environment, the fee could save you significantly more than it costs.

There is no universally "right" answer when it comes to choosing between fixed and variable rates. The best choice depends on your personal circumstances, financial goals, and tolerance for risk. Here is a framework to help you decide.

Start by honestly assessing your financial buffer. If a rate increase of 1-2% would cause genuine hardship, you should seriously consider fixing at least a portion of your loan. Peace of mind has real value, and the certainty of fixed repayments can prevent sleepless nights when the central bank is in a tightening cycle.

Next, consider your plans for the next three to five years. If you are settled and unlikely to sell, refinance, or make large extra repayments, a fixed rate carries fewer risks. If your life is in flux — you might move interstate, change careers, start a family, or come into an inheritance — the flexibility of a variable rate is more valuable.

Finally, consider the rate environment. If fixed rates are significantly higher than variable rates, you are paying a premium for certainty. If the gap is small or fixed rates are lower, the case for fixing is stronger. Your mortgage broker can provide current rate comparisons and help you model the cost difference between fixed and variable under different interest rate scenarios.

Test different rate scenarios with our borrowing power calculator to see how fixed and variable rates affect your repayments and total loan cost.

Explore how your deposit size interacts with your rate choice