Fixed rate loan
Fixed rate loans protect you against the risk of an interest rate rise by fixing the interest rate applicable to all or a portion of, your loan for a set period of time. If interest rates rise, you will have the security of knowing the interest rate on the fixed portion of your loan and your regular repayments will not change until the end of the fixed period.
- Fixed rate loans are often higher than variable rate loans.
- If variable interest rates fall during the term of your fixed interest rate loan, you won’t benefit from this.
- Fixed rate loans generally have limited features and restrictions are applied on additional repayments which may prevent you from accelerating the repayment of your loan.
- Early payout fees usually apply to fixed rate loans.
Variable rate loan
Variable rate loans have an interest rate that may change. Therefore, minimum repayments may vary with changing interest rates. Often, variable rate loans have a lower interest rate than fixed rate loans. Variable rate loans also have greater features than fixed rate loans, such as the ability to make additional repayments, vary payment frequency, redraw facility, offset facility and portability.
- If interest rates rise, your variable rate loan and repayments are also likely to rise.
- If you are not using all the features of your variable rate loan, you may be paying a higher interest rate than needed.
Consolidating your debt/ Debt Management
A simple strategy to lower your overall interest rate and more easily manage your debt is to consolidate all debts into one loan that provides a lower interest rate and features to help you repay your inefficient debt faster.
In some cases, it may be appropriate to consider replacing inefficient debt with more efficient debt that can be used to create wealth tax effectively. This strategy is known as debt recycling but should only be undertaken after a thorough analysis of your financial situation. Debt recycling can be an effective strategy to accumulate wealth over the long-term. It is a process of using surplus capital or cash flow to reduce inefficient debt and then replacing it with efficient debt in the form of an investment loan. The investment loan proceeds are then invested to form part of your investment portfolio. The inefficient debt is eventually extinguished and an investment loan with fully tax deductible interest remains. There is no tax benefit available on debt used for personal purposes, but a tax deduction is available on the interest expense on investment loans where the loan is used to purchase income producing assets. Debt recycling therefore results in a more tax efficient outcome and wealth accumulation benefits through the accumulation of an investment portfolio. Note the investment loan would need to be repaid at some point in time.