An adjustable-rate mortgage (ARM) is the American name for a home loan whose interest rate can change. In Australia, the nearest match is a standard variable-rate home loan. Your lender changes the rate, which can increase or reduce your repayments.
The Australian loan usually has no contractual ceiling on rate rises. A capped variable loan is the occasional exception, with protection that lasts for a limited period.
The Australian Versions of an Adjustable Rate
Australian borrowers encounter a moving rate through three loan structures.
- A pure variable loan has a rate that changes when the lender reprices the product.
- A fixed-then-revert loan starts with a fixed period and then moves to a variable rate. It is the closest Australian equivalent to a hybrid ARM, although its later pricing follows Australian lender terms.
- A split loan has separate fixed and variable portions. Only the variable portion changes during the fixed term.
Compare the rate the borrower will pay after an introductory discount ends, called the revert rate. A low honeymoon rate can hide a more expensive ongoing loan. For fixed terms and the wider comparison, see fixed-rate mortgages in Australia.
Variable Rate Home Loans in Australia
A variable home loan changes as the lender responds to funding costs, competition and its profit margin. Reserve Bank decisions influence those costs. Inflation and employment data help shape the Reserve Bank's decisions and market expectations.
Two lenders can respond differently to the same cash-rate change. Their deposit funding, wholesale borrowing costs and appetite for new lending differ. One can pass on a cut in full while another passes on only part.
The advantages and risks depend on the product's terms.
- A rate cut can lower the interest charged and the required repayment.
- Extra repayments, redraw and an offset account can help reduce interest, where the product includes them.
- Refinancing or selling generally avoids fixed-rate break costs, although discharge and switching costs can remain.
- A rate rise increases interest costs and can stretch the household budget.
- The lender can change its rate independently of the Reserve Bank, so repayment certainty is limited.
Review the rate each year. Within a couple of years, a loan can cost more than the lender's new-customer offers. Compare a like-for-like product and ask the existing lender to reprice before paying to refinance.
The Reserve Bank's analysis of mortgage pricing describes how competition and borrower negotiation have narrowed the average gap between new and existing loans. An annual review checks your own rate instead of assuming that average applies to you.
Features Worth Checking
US ARMs commonly calculate later rates from an index plus a lender margin. Their contracts can also limit individual increases and total increases over the loan's life. The US Consumer Financial Protection Bureau explains these ARM rate caps.
Australian variable lenders generally reprice at their discretion under the loan contract, without that index-and-margin formula or a lifetime cap. Capped variable products provide a temporary exception, described in the next section.
- Confirm the revert rate after any introductory discount and after a fixed term.
- Review the product's rate-change history, including changes made independently of Reserve Bank decisions.
- Check offset access, redraw and extra-repayment terms on the discounted product itself.
- Compare exit costs, including discharge charges and any break cost on a fixed portion.
Capped Variable Rates
A capped variable loan lets the rate fall while preventing it from rising above a ceiling during an agreed window. When that window ends, the loan reverts to its ordinary variable rate.
These products appear only occasionally, including through smaller lenders' campaigns. Their starting rate usually sits above a basic variable rate, so the borrower pays for protection before the cap is reached.
Model the capped loan to the end of its window against a matching fixed term and the cheapest variable loan the client qualifies for. Include fees and the remaining balance, alongside repayments.
This hypothetical example uses a $500,000 principal-and-interest loan over 30 years, monthly repayments and a three-year comparison period. It excludes fees, offset savings and extra repayments. Rates and the cap are illustrative, not lender offers.
| Loan | Rate Assumption | Monthly Repayment | Interest Over Three Years | Balance After Three Years |
|---|---|---|---|---|
| Capped variable | 6.4% for one year, then 7.5% at the cap for two years | $3,128, then $3,488 | $105,260 | $484,008 |
| Three-year fixed | 6.2% throughout | $3,062 | $91,345 | $481,101 |
| Lowest qualifying variable | 6% for one year, then 8% for two years | $2,998, then $3,654 | $108,151 | $484,475 |
In this rising-rate example, the cap limits the later repayment, but the fixed loan costs less over the window. Repeat the comparison with falling and unchanged rates. Then test the capped loan's revert rate, because its ceiling ends.
Negative Amortisation: Mostly an Import Problem
Negative amortisation happens when a payment covers less than the interest due and unpaid interest increases the debt. Some US payment-option ARMs permit this through a low minimum-payment option.
A standard Australian principal-and-interest schedule covers interest and repays some principal with each scheduled payment. When rates rise, the required repayment adjusts to keep the loan on its repayment schedule. Missed payments can still create arrears.
Long interest-only periods are the local warning sign when assessing repayment risk. Paying all interest leaves the principal unchanged, then the borrower must repay that balance over the shorter remaining term. Interest-only borrowing does not itself cause negative amortisation, but the later repayment jump needs testing. Moneysmart explains the costs of interest-only home loans.
Who Sets the Rate
The Reserve Bank sets the cash-rate target, while each lender sets its own mortgage rates. Lenders need not move by the same amount or at the same time. See the Reserve Bank's cash-rate target table for the target and its changes.
For how that benchmark is decided, see the Australian cash rate. The target influences mortgage pricing but does not dictate your loan's rate.
The Australian Prudential Regulation Authority (APRA) requires authorised deposit-taking institutions (ADIs) to assess mortgage repayments with a buffer of at least three percentage points. Its APS 220 credit risk standard applies the buffer to the ongoing loan rate, ignoring a temporary introductory discount.
This ADI requirement does not apply to non-bank lenders. A non-bank can still apply its own serviceability buffer. Passing a lender's assessment also leaves you responsible for checking the repayment against your household budget.
Choosing the Structure
A variable loan fits borrowers who can absorb a rise of several percentage points, or who expect to sell or refinance soon. Offset access and unrestricted extra repayments can also favour variable borrowing where those features are available.
For a tight budget, price a fixed or split option to reduce exposure to a repayment increase. Allow for the fixed portion's restrictions and its eventual revert rate. See splitting a home loan between fixed and variable rates for the decision about proportions.
Model the client's repayment at today's rate plus three percentage points. On a hypothetical $500,000 principal-and-interest loan over 30 years, moving from 6% to 9% increases monthly repayments from about $2,998 to $4,023. That is roughly $1,025 more each month, excluding fees.
If the stressed repayment fits comfortably, a variable structure can remain in consideration. If it fails the budget, price a fixed or split alternative before lodging the application.
