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What is a variable interest rate loan?

A variable interest rate loan can rise or fall whenever the lender decides to move it. This is the opposite of a fixed rate, which remains the same during a set period of time.

• Lenders raise or lower their rates depending on various factors, such as their funding costs (where they get the money to cover mortgages), a desire to be competitive or changes to the official cash rate.

• Despite this volatility, variable rate mortgages don't usually change every month. A rate increase means your repayments rise, but a rate drop means your repayments could get cheaper.

Three types of variable home loans

Most lenders offer multiple variable rate home loans with some key differences.

1. Basic variable home loans have a lower rate than a lender's other products (usually) and don't have as many features. If you want a simple variable rate loan with no offset account, a basic loan is a good option.

2. Introductory discount home loans are often the lowest variable rate loans a lender has (even lower than its basic loans if it has those). But here's the catch, after that initial discounted period the rate will revert to a higher variable rate.

Example:

• Home loan: Two-year introductory special discount variable home loan

• Introductory rate: 1.99%

• Revert rate: 2.35%

In plain English, this home loan starts at 1.99% for the first two years and then reverts to a higher (but still competitive) rate.

• Be smart: Introductory discount variable rates can be great home loans. You just need to be aware that the low rate won't last forever. And if it does jump up too high you should consider refinancing to a better rate.

• Go deeper: compare introductory discount home loans

3. Standard variable rate loans are a bit of a throwback. These are the benchmark variable rates used by the Big Four banks and some other lenders.

• Be smart: Standard variable rates are often considered to be a default offer. But these products have much higher rates than the most competitive loans offered by lenders.

6 Key Things to Look For in a Variable Home Loan

The best variable rate home loan really depends on your needs as a borrower.

• If you're an investor planning to "flip" a property quickly you need a very different variable mortgage compared to an owner-occupier looking to buy their first home.

Here's 6 key things to look for:

1. Get a low variable rate: With any home loan a lower interest rate makes for a better home loan. A lower rate means lower repayments and it makes your home loan cheaper.

Here's a quick example using the same loan amount but with a 31 basis point difference in the rate:

• Go deeper: You can use a repayment calculator to see the difference between various rates or check the repayment column in the loan table above.

2. Look at the loan purpose and repayment type: Even the lowest rate on Earth is not very useful if you have the wrong loan type.

• If you're looking to finance an investment property then you will need an investment loan.

• If you're buying or refinancing a loan for the home you live in then you need an owner-occupier home loan.

3. Principal and interest versus interest-only loans: Variable home loans can have either principal and interest repayments or interest-only repayments. And there are big differences between them.

• Principal and interest loans mean you repay the loan (the principal) and interest charges together. This is the most common type of variable home loan, especially for owner-occupiers.

• Variable interest-only loans let you avoid repaying any loan principal at first. This makes your repayments cheaper to start with. But over time, once you start repaying the debt your repayments jump up and you end up paying more in the long run.

• Interest-only loans are more common for investors using specific investment strategies. But owner-occupiers can use them too.

4. Get a loan with the right features: A variable loan's features can be useful, if you use them. For example, if you have extra savings, you can use an offset account to save the cash and minimise your interest payments.

• Be smart: If you don't need this feature, you can look for a loan without it, which might have a lower interest rate.

5. Extra repayments: a common feature on variable rate loans.

• Why it matters: Being able to make extra repayments can help you repay your loan faster and pay less interest.

• Yes, but: If your loan has an offset account you can put the extra repayments there instead of making extra repayments. It has the same effect but gives you more control over the money.

6. Look for a loan with low fees: A variable rate home loan can come with a range of fees. If the loan works for you and the interest rate is low, a few fees aren't so bad. But if you can avoid fees, then why pay more?

• Be smart: Another advantage of a variable rate loan over a fixed loan is that refinancing is cheaper. There may be a loan discharge fee, but break costs no longer apply on variable rate loans.

How does the RBA cash rate affect variable rate loans?

Every month (except January) the Reserve Bank sets the official cash rate. This rate affects the funding costs of variable home loan interest rates.

• Why it matters: If the rate rises, you can expect lenders to increase their variable rates. If the rate falls, most lenders will pass on some (or all) of the cut to their variable rate customers.

When the RBA cuts it can mean savings for variable borrowers. In 2019, the RBA cut the cash rate three times, in June, July and October and then it cut twice in March 2020. Each cut was 25 basis points (or 0.25%).

• This meant big savings for variable borrowers, with some lenders passing on close to the full 25 basis points each cut.

• Yes, but: when the RBA cut the cash rate again in November 2020 lenders cut fixed rates instead.

• Be smart: So the RBA's decisions are no longer a clear benchmark for what will happen to variable interest rates.

When the RBA raises rates it often means borrowers' interest rates increase. In 2010, the Reserve Bank raised the cash rate four times, which meant many variable borrowers found their interest rates increasing substantially.

Should I choose a variable home loan rate or a fixed rate?

While variable rates can change any time, there are several reasons many borrowers prefer them.

1. Variable rates have greater flexibility. With a fixed rate home loan you are locked in for a specified period of time. While your rate won't change, it's harder to refinance or exit during the fixed period. The breaking costs to do so can run into the thousands of dollars. Variable rate loans don't have that issue as there are no breaking costs on these loans.

2. Variable rates have more loan features. You can find a competitive fixed rate loan with an offset account. But you have a lot more options if you're looking for a variable rate loan with one. The same goes for redraw facilities, which allow you to make extra repayments and then pull the money back out to spend if you need it. Some fixed rate loans limit the amount you can make in extra repayments and restrict the amount you can redraw.

3. But, variable rates are not the lowest rates on the market at the moment.

• In past years variable rates have reliably been lower than comparable fixed rate loans.

• Yes, but: According to Finder's lowest home loan rate tracker, in November 2018 the lowest variable rate owner-occupier loan had a rate of 3.54%. The lowest fixed rate then was 3.74%. That's a 20 basis point difference. In November 2020 the lowest fixed rate was 1.89%, beating out the lowest variable rate of 1.99%.

• Looking across offerings on the market it's clear that a lot more fixed rates start with a 1, while most of the lowest variable offers start with a 2.

4. Low rates are here to stay. With both fixed and variable rates being so low at the moment the choice to fix is more complex than ever. You could actually lock in a very competitive rate for several years. At the same time, the Reserve Bank of Australia has made it fairly clear that the low rate environment will be here for the next few years. This means there's less urgency to fix.

Go deeper: read more on variable vs fixed home loans

Still unsure? Consider the split rate option: Many lenders allow you to split your loan into fixed and variable portions.

• You can divide your loan amount into equal fixed and variable portions, or in any proportion you choose.

• Be smart: Splitting lets you enjoy the stability benefits of a fixed rate and the flexibility of a variable rate. It's a little complicated, but your lender or a mortgage broker can help you calculate the best split for you.