Variable Interest Rate Mortgage: What It Is and How It Works

Unlike fixed-rate loans, where your interest rate stays the same for a set period, a mortgage variable interest rate means your interest rate and repayments can move up or down over time.

Variable rate mortgages are a popular choice among Australian borrowers, especially those seeking flexibility in managing their home loans. 

And as property prices across Australia keep reaching new heights, the type of your mortgage interest rate setup requires closer attention. Because even a 0.5% difference over 30 years could mean tens of thousands of dollars saved or spent.

That's why understanding how variable rates work, and when they might work against you, is so important today.

Mortgage Variable Interest Rate Explained

A variable interest rate mortgage is a type of home loan where the interest rate can change at any time. 

That means your repayments can increase or decrease, usually influenced by shifts in the Reserve Bank of Australia’s (RBA) official cash rate, along with broader economic conditions and decisions made by your lender.

In simple terms, if the interest rate goes down, you could pay less. If it goes up, you could pay more.

Here’s what makes up your variable rate:

• The RBA's cash rate.

• Your lender's margin (their profit).

• Any discounts you qualify for.

How Does a Variable Rate Mortgage Work?

When you take out a variable rate home loan, your lender sets an initial interest rate, which is typically influenced by the RBA’s current cash rate. 

But unlike a fixed-rate mortgage (where your rate stays the same for a set term), a variable rate can fluctuate over the life of your loan. 

Think of it like a sliding scale where your repayments move with the financial markets, rather than being locked into one position like with fixed rates.

What Influences Your Variable Rate?

Lenders might adjust your rate due to:

• Changes to the RBA cash rate.

• Market competition among banks and lenders.

• Their own cost of funding.

• Risk assessments or internal policies.

Your minimum repayment amount will adjust up or down depending on the rate change. The interest portion of your repayment changes immediately, and your loan term may slightly extend or shorten depending on your new repayment structure.

For example:

If you have a $500,000 home loan on a 30-year term at a 6.00% interest rate, your monthly repayment would be approximately $2,998.

• If your lender increases the rate to 6.50%, your repayment rises to around $3,160.  

• If the rate drops to 5.50%, your repayment falls to about $2,838.

This shows how even a small change in interest rates can make a noticeable difference to your monthly budget.

If you want to see how your loan would respond to rate changes, use the MoneySmart Mortgage Calculator to test scenarios.

How Are Variable Rates Set?

Every month (except January), the Reserve Bank meets to set the official cash rate (the interest rate that commercial banks pay on the money they borrow) based on economic conditions like inflation and employment. 

This becomes the baseline for interest rates across the economy. You can check the current cash rate anytime on the Reserve Bank’s website.

Once the RBA makes a decision, lenders choose whether or not to adjust their own variable rates. They often do, but not always, and not necessarily by the full amount.

For instance, while the RBA might lower the cash rate by 0.25%, your bank could:

• Lower your rate by the full 0.25%.

• Reduce it by a lesser percentage.

• Keep it unchanged, depending on other pressures.

So ultimately, your lender decides what variable rate they offer you. That’s why it’s important to review your rate regularly and shop around if needed. You may be able to negotiate a better rate or find a more competitive offer elsewhere.

Pros and Cons of Variable Rate Mortgage

Pros:

1. Potential to Benefit from Rate Drops: If the RBA lowers the cash rate and your lender passes it on, your interest rate and your repayments go down, saving you money or giving you the chance to pay off your loan faster by keeping repayments steady.

2. More Flexibility in Managing Your Loan: Variable loans often allow higher/unlimited extra repayment limits, redraw facilities to access those extra funds if needed, and offset accounts to reduce the interest charged.

3. Fewer Exit Penalties: Unlike fixed-rate loans, most variable loans don’t charge break fees. That means you can refinance, switch lenders, or pay off your loan early without heavy penalties.

4. Competitive Offers and Discounts: Lenders frequently offer discounted variable rates or special deals to attract new customers, especially if you have a good credit profile, strong LVR, or larger deposits.

Cons:

1. Repayments Can Increase Without Warning: When the RBA or your lender increases rates, your mortgage repayments go up. This could put pressure on your monthly budget, especially if you’re not prepared, leading to mortgage stress.

2. Less Predictability for Long-Term Planning: With a variable rate, your repayment amount can change multiple times a year, making it harder to set and stick to a consistent budget.

3. No Protection Against Rate Hikes: Unlike fixed loans, variable rates offer no cap, leaving you exposed to multiple increases over time.

4. Potential Stress or Uncertainty: For some borrowers, the lack of stability can feel overwhelming, particularly during times of economic volatility or personal financial strain. 

Why Choose a Variable Mortgage Rate?

One of the biggest advantages of a variable rate loan is the potential to save money when rates fall. 

So, if interest rates go down or stay lower for a decent stretch, you could save thousands compared to locking in on a fixed rate. Even a small change can have a noticeable impact. For example:

• A 0.50% rate drop on a $500,000 loan over 30 years could reduce monthly repayments by around $160. 

• That’s nearly $1,900 in savings per year, or more if you keep paying the original amount and chip away at your principal faster.

But it’s not just about the rate itself. The savings also come from how you use the flexibility:

• Putting lump sums towards your loan when possible.

• Using an offset account effectively.

• Making higher repayments when your rate drops (instead of lowering them).

If used wisely, a variable loan can help you pay off your loan faster, cutting down your total interest paid.

Who Should Consider a Variable Rate Loan? 

A variable rate loan is ideal if you can handle a little fluctuation in your monthly budget. 

It’s often a good fit for people who have a steady income, some savings set aside, or who don’t plan to hold onto the property for a long time. 

These borrowers are usually in a better position to handle rate increases and take advantage of savings when rates fall.

How to Find or Negotiate the Best Variable Home Loan

When comparing variable home loans or looking to switch, keep these essentials in mind:

• Loan-to-Value Ratio (LVR): Some lenders offer lower rates if your LVR is under a certain threshold (like 80%). The lower your LVR, the stronger your position to negotiate.

• Interest Rate & Comparison Rate: Look beyond the headline rate. The comparison rate includes most fees and gives a clearer picture of the loan’s true cost.

• Loan Features: Offset accounts, redraw facilities, and extra repayments can help reduce interest. Prioritise the features you’ll actually use, especially if they come with a higher rate.

• Flexibility & Future Costs: Consider any exit or switching fees, and whether the loan allows you to refinance or make changes easily if rates rise or your plans change.

• Lender Experience: Look at customer service, digital tools, and perks for bundling other products.

What Are Your Options If You’re Unsure?

If you’re not entirely comfortable going fully variable, you might want to consider a split loan, where part of your mortgage is fixed and part is variable. 

It’s a good way to get a taste of both worlds: security on one side, and flexibility on the other.

Either way, having a broker will help you go through the entire process smoothly. They can help you:

• Identify the right mortgage setup.

• Guide you through the mortgage process from start to finish.

• And even perform actions for you on your behalf.

That said, the quality of service you get depends on the broker you find. Here at Koalify, we help Aussies dreaming of a home to search, curate, and get a mortgage for free.

No hidden fees, consultation charges, or commissions whatsoever! 

And driven by ASIC’s Best Interests Duty, we guarantee to find you the most suitable home loan that fits your unique needs and goals. 

With our extensive panel of 30+ top lenders and 2,000+ mortgage solutions in Australia, you can unlock opportunities that you might miss otherwise. 

Interested? Contact us to get your dedicated mortgage advisor today!

Conclusion

A variable rate mortgage can be a powerful option, offering flexibility, useful features, and the potential to save when rates move in your favour. 

But it also comes with a level of unpredictability that not every borrower is comfortable with. 

Understanding how variable rates are set, and what influences your repayments, can help you decide whether this type of loan fits your financial situation and long-term goals. 

Note: This information is of a general nature only and does not take into account your objectives, financial situation, or needs. Kindly consider seeking independent, licenced credit advice before acting.

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