Top tips to understand variable rate home loans

What is a variable rate home loan?

A variable rate home loan has an interest rate that can move up or down during the loan term, usually in response to changes in the official cash rate or the lender's funding costs. The lender decides when and by how much to adjust the rate, though most lenders move their rates in line with Reserve Bank announcements.

In our experience, borrowers choose variable rates when they value flexibility and want the option to make extra repayments without penalty. Consider a buyer in South Perth who purchased an older-style unit near the foreshore. She selected a variable rate with an offset account and began directing her salary into the offset each month. Within three years, the offset balance reduced her interest charges by several thousand dollars, and when she received a work bonus, she made a lump sum payment directly onto the loan without incurring break costs. The variable structure allowed her to adapt her repayment strategy as her income changed.

Variable rates generally include more loan features than fixed rates, such as offset accounts, redraw facilities, and the ability to make unlimited additional repayments. If your rate decreases, your repayments may fall or more of each payment goes toward reducing the principal. If your rate increases, your repayments rise unless you have built up a buffer through an offset or redraw.

How variable rates are determined

Lenders set variable rates based on their wholesale funding costs, the official cash rate, and their own risk and profit margins. Each lender operates independently, so rate movements and discounts vary across the market.

When the Reserve Bank changes the official cash rate, most lenders adjust their variable rates within a few days. However, lenders also adjust rates outside the Reserve Bank cycle in response to funding cost changes or competitive positioning. South Perth borrowers with loans across different lenders may notice that one lender moves rates more frequently or by larger increments than another, even when both are responding to the same economic conditions.

Rate discounts are negotiated at the time you apply for the loan and are typically influenced by your deposit size, loan amount, and the loan-to-value ratio. A borrower with a 30% deposit and a loan amount above $500,000 will usually receive a larger discount than a borrower with a 10% deposit and a smaller loan. The discount applies to the lender's standard variable rate and remains in place for the life of the loan unless renegotiated.

Offset accounts and how they reduce interest

An offset account is a transaction account linked to your home loan, and the balance in the offset is subtracted from your loan balance before interest is calculated each day. If you have a loan balance of $500,000 and $30,000 in your offset account, you pay interest on $470,000.

Offset accounts are standard on most owner occupied home loans with variable rates, though some lenders charge a small monthly fee for the feature. The interest saved through an offset is often greater than the interest you would earn in a standard savings account, particularly when your marginal tax rate is considered. In a scenario where a South Perth borrower maintains an average offset balance of $25,000 and the variable rate sits at current levels, the annual interest saving would exceed the after-tax return from a deposit account paying a competitive savings rate.

The offset works in real time, so every deposit reduces the interest charged that day. Borrowers who use the offset strategically by parking their salary, tax refunds, and other irregular income in the account can reduce the total interest paid over the life of the loan and shorten the loan term without formally increasing their repayment amount.

Variable rate features that support flexibility

Variable rate products typically include redraw facilities, which allow you to access extra repayments you have made above the minimum required amount. Redraw is useful when you want to reduce your loan balance quickly but retain access to those funds in case of an emergency or opportunity.

Most variable loans also allow unlimited additional repayments without penalty. This contrasts with fixed rate loans, where additional repayments are often capped at a set amount per year and exceeding that cap may trigger break costs. Portability is another common feature, allowing you to transfer your loan to a new property without reapplying or paying discharge fees, though the lender will reassess the security and may adjust the rate or terms.

Refinancing from a fixed rate to a variable rate is common when borrowers want access to offset accounts or the ability to make larger repayments. South Perth property owners who refinanced in recent years often did so to take advantage of variable rate features after their fixed term ended, particularly if they had accumulated savings or expected irregular income from bonuses or investment returns.

When a variable rate may not suit your circumstances

Variable rates expose you to interest rate risk. If rates rise significantly, your repayments increase and your borrowing capacity for future lending may be affected. Borrowers on tight budgets or those who prefer certainty in their monthly expenses may find this volatility difficult to manage.

In our experience, borrowers who are purchasing at the top of their borrowing capacity or who have limited capacity to absorb repayment increases tend to favour fixed rates or split loan structures. A split loan divides your borrowing between a fixed portion and a variable portion, allowing you to lock in part of your repayments while retaining flexibility on the remainder. The fixed portion provides stability, while the variable portion gives access to offset and redraw features.

Another scenario where variable rates may not suit is when you expect to hold the loan for a short period and want to avoid any risk of rate movement during that time. For example, a borrower purchasing a property in South Perth with the intention of selling within two years might prefer a fixed rate for the full term to eliminate repayment uncertainty during the holding period.

Comparing variable rate products across lenders

Variable rates and features differ significantly across lenders. Some lenders offer lower headline rates but charge fees for offset accounts, redraw, or annual package fees. Others offer higher rates but include all features at no additional cost. When comparing products, calculate the total cost over the period you expect to hold the loan, including interest, fees, and any lender-specific charges.

First home buyers in South Perth often focus on the advertised rate without reviewing the comparison rate, which includes most fees and charges. The comparison rate provides a more accurate picture of the total cost, though it assumes you hold the loan for 25 years and borrow a standard amount, so it may not reflect your specific circumstances.

Some lenders also apply rate discounts that increase over time or offer loyalty discounts after a set period. Others offer discounts linked to holding other products with the same institution, such as a transaction account or credit card. These discounts can reduce your rate by 0.10% to 0.30%, which compounds to a significant saving over the life of the loan.

Rate reviews and how to respond to increases

When your lender increases your variable rate, your first option is to absorb the increase and continue with your current repayment amount. Your second option is to contact your lender and request a rate reduction or negotiate a better discount. Lenders often retain discretion to adjust rates for existing borrowers, particularly if you have a strong repayment history, a low loan-to-value ratio, or a large loan balance.

If your lender is unwilling to adjust your rate, refinancing to a new lender may reduce your rate and provide access to additional features or lower fees. South Perth borrowers who refinance typically do so when their rate has increased multiple times without a corresponding reduction when the market moves in the other direction, or when they identify a product with significantly lower ongoing costs.

A loan health check is a structured review of your current loan against available market alternatives. It includes a comparison of rates, fees, features, and eligibility across multiple lenders. In many cases, refinancing delivers a lower rate, an offset account, or the removal of monthly account fees that were eroding the value of the original loan.

Call one of our team or book an appointment at a time that works for you to review your current variable rate loan and explore whether your rate and features remain suitable for your circumstances.

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