Fixed vs Variable Loan Allocation

The decision to fix your home loan or leave it on a variable rate depends on many factors.

This entry doesn't propose to address the chief one among them - what are interest rates going to do in the future? If we knew the answer to that, the decision to fix or stay with variable would be an easy one. We do know that fixed rates are currently lower than variable (although trending up at time of writing), and there is an immediate gain to be had by fixing the home loan and paying less interest today, regardless of what may happen in the future.

However, the problem is that, unlike variable loans, most fixed loans do not allow for additional repayments. Whether by using offset accounts, redraw facilities, or just additional payments, it's possible to reduce the interest charged on the variable loan by reducing the amount the interest is calculated on. Zero interest is, of course, better than lower interest - but that option isn't there for fixed loans.

A Hybrid Approach

Which means that the ideal set up would include a portion that is fixed, and a portion that is variable. The variable portion allows us to make additional repayments. The fixed option offers a lower interest rate. This set up has the side benefit of hedging your bets regarding the question we refused to answer at the start - "What are the rates going to do?" Since we have both a fixed an a variable portion, our effective total interest rate is going to be somewhere between the fixed and variable.

The question becomes - what portion of the loan should we fix? The ideal allocation will take into account our additional repayments over the life of the fixed loan while maximising the amount we fix for the benefit of lower interest rate.

Modelling the Ideal Allocation

That's why we've created the Fixed vs Variable calculator. It works out the optimal allocation based on the ideas above.

One additional wrinkle the calculator considers is the interest you can expect to accrue elsewhere. So, for example, if you are able to earn 8% interest elsewhere, an offset account offsetting a 3% loan may not be the ideal place for your money. So, the calculator asks for your Savings Account Rate and Tax Rate (since interest earned will be subject to tax at your marginal rate).

So, happy calculating! And please feel free to get in touch with us via the contact form or on twitter @graphsandstuff.