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A new loan can be a life-changing commitment. You may feel a little pressure to choose the right type of loan.
It’s an opportunity to grow your wealth, but there are layers of decisions you need to make before the paperwork is finalised. The good news is, you can combine the benefits of both a fixed and variable interest rate into one loan.
For investors who are juggling cash flow or families with changing priorities, choosing a combined fixed and variable loan just makes the most sense. A combination loan gives you financial flexibility so you’re prepared for the future and a level of certainty so you can make plans in the short term.
Most financial lenders offer two main options when it comes to loans: a fixed or a variable interest rate on the borrowed amount. Choosing one or the other may feel like a gigantic commitment, and lenders will brand each loan differently, so it’s not always straightforward what the details or benefits are.
On the surface, a fixed loan appears simple. Find the lender with the lowest interest rate, lock it in for five years and walk away. A fixed loan provides borrowers with certainty and security.
But what if your circumstances change? What if you want to borrow more or pay down the debt sooner? Unless you pay a penalty, a fixed loan will stay fixed.
The variable loan offers much more flexibility. Borrowers can make additional repayments and can effectively reduce the principal amount faster. The interest rate is typically slightly higher than the fixed loan and it will fluctuate with the markets. This can create uncertainty for borrowers and most want to avoid the whim of the markets.
Borrowers need to ask lenders loads of questions and understand exactly what penalties are in place for each loan option. The first step is to decide what’s important to you.
A fixed loan keeps your finances simple. This type of loan makes budgeting easy for borrowers, because the repayment amounts are set in stone. A fixed loan effectively locks in the interest rate for a specific timeframe. A fixed loan can last up to five years and then it rolls into a variable arrangement automatically.
This loan is a straightforward commitment for the borrower. The repayments are set fortnightly or monthly, and the amounts remain unchanged.
This certainty and clarity make it easy for borrowers to compare loans between lenders and protects them from interest rate fluctuations. If you have a set income or you need to carefully coordinate cash flow, a fixed loan is ideal.
It’s true that financial certainty brings financial confidence, but a lot can happen in five years.
A detached fixed loan does not permit additional payments, nor can it attach to an off-set account. This means that if your income rises or your side hustle blossoms or you receive a financial bonus or an inheritance or perhaps you simply wish to reduce your loan with extra savings – there’s no flexibility on a fixed loan to pay your principal down sooner. A variable loan has this flexibility.
A variable interest rate will rise and fall throughout the duration of the loan.
The interest rate is loosely based on the cash rate set by the Reserve Bank of Australia, but the lender will have the final decision. Borrowers essentially agree to unknown repayment amounts that rise and fall regularly.
Of course, the main goal is to reduce the principal debt as quickly as possible, so this interest rate fluctuation can make borrowers nervous. But a variable loan offers enormous flexibility to counter this ambiguity.
With a variable loan, lenders offer an offset account. Borrowers can make extra payments to the principal of the loan into the offset account, without any penalties. Borrowers can build savings on the offset account, reducing the principal of the loan (saving thousands in interest) and can also dip in and spend the offset amount on other things, if needed. There are no fees for this flexibility.
A combination loan of both fixed and variable interest rates allows borrowers to receive financial certainty and flexibility. It just makes sense to have one part of the loan set in stone. It reduces the risk of unpredictable and volatile repayments.
Borrowers can plan ahead knowing what their financial commitments are, while the other part of the loan allows extra repayments if the cash flow is available.
Putting extra cash flow into an offset account can reduce the loan amount and save thousands by the end of a loan, even if the borrower chooses to use the extra savings for a holiday during the loan term.
The key to financial confidence is finding the right balance for you.
Step Up Group can help you take control of your financial future and help you make the right choice for your circumstances. Using the Step Up Financial Process, we help you launch the plan that will grow your wealth, protect your wealth and keep you in control.