Understanding what an interest rate is and the way in which it works is fundamental for each potential borrower. At the end of the day, it is a significant element that establishes the cost of the loan and the amount of money you’ll pay on a monthly basis. Even the slightest difference in interest rates will result in a major price reduction or increase in your loan terms.
What Are the Main Types of Interest Rates?
To begin with, you should know that the Reserve Bank of Australia is responsible for establishing the interest rates. This rate is reviewed on a monthly basis, and it is this rate loan that providers utilise in order to determine their interest rates.
Concurrently, lenders may choose to diminish or increase the rates, depending on the current cash rate. That being said, interest rates are separated into four broad categories, as follows:
- Fixed Rate
A fixed interest rate means instituting an interest rate on the loan, for up to five years. Obviously, this will offer you protection in the case in which the interest rates are on the growth. Having a fixed repayment sum will make it easier for your budget.
On the other hand, if the cash rate happens to drop, you won’t take advantage of this. What is more, if you want to minimise your debt by making additional repayments, certain restrictions might apply, as well as additional fees.
- Variable Rate
Essentially, a variable interest rate is due to change depending on the alterations in cash rate, or the changes made by your loan provider. Apart from the obvious advantage that the interest rate might drop when the cash rate does, there are also no imposed constraints regarding making additional repayments.
Still, in the reverse situation, if the cash rate goes up, your interest rate will be higher, as well. This will significantly increase the size of your repayments.
- Partially-fixed rate
A partially-fixed rate loan, or a split loan, allows you to enjoy the benefits associated with both variable and fixed loans. Simply put, you may pay a fixed rate over a given timeframe and a variable rate from that point onward.
A split loan might be an excellent alternative if you want to enjoy the security linked to regular repayments while also taking advantage of potential interest rate drops. What is more, the norm is that there are no restrictions or fees applied when it comes to making additional repayments.
In spite of that, this type of interest rate still minimises your flexibility, in comparison to a fully variable loan. To that end, if the interest rates happen to diminish, you won’t be able to take full advantage of that until the fixed period of the loan expires.
- Introductory rate
There are loan providers that facilitate more affordable interest rates in the first one or two years of the loan. Such interest rates are referred to as introductory rates or honeymoon rates. While this could appear like an excellent option at the time, you should also determine if you’ll afford to make repayments when the honeymoon period comes to an end.
To sum up, choosing between interest rates is an important decision that could help you to save up to thousands of dollars. Thereupon, make sure you compare different rates, before agreeing to any loan terms!