First home buyers and current home owners know that it's currently not a matter of if interest rates will rise but when - a situation that's making home borrowers nervous. Why? Because many borrowers are already overstretched or highly geared. A jump in rates of 1% to 2% over the next year could add $400 to monthly repayments.

According to the Australian Bureau of Statistics, in the year to June 2009, 96% of new owner-occupier home loans (that's around 650,000) were variable loans. That's not a big surprise. Interest rates have been at their lowest for a generation and it hasn't cost much to borrow.

But everyone with a variable rate loan now faces the prospect of rate rises that could put them under serious financial strain.

Changing to a fixed loan?

As a result, many people are now considering the idea of fixing their mortgage. Indeed, fixed rate loans accounted for 8% of new loans taken out in June 2009, as compared to only 2% in December last year.

But is fixing your home loan the best thing to do? To properly answer this question, you need to weigh up the pros and cons of fixing your mortgage.

A big advantage of a fixed loan is that you fix your minimum monthly, weekly or fortnightly repayment. This offers some financial and emotional security against rate increases during the fixed rate period (usually between two and five years), which can be of benefit if you're highly geared or if you're a new borrower unused to the heavy burden of loan repayments.

On the flipside, fixed rate loans are fairly inflexible and lack many of the features of variable loans. To compensate for lost interest, fixed rate loans also have big penalties for early termination, especially if you terminate early on in the fixed rate term.

Think about payment certainty, not overall savings

So, is fixing your loan the best move? The key is to view fixed rate loans as a way to achieve repayment certainty - not, as some do, as a way of saving money.

There's no guarantee that you'll end up saving money using a fixed rate loan - in fact, it could result in you paying more. Simply ask those borrowers who fixed their home loans just before the global financial crisis, when rates suddenly dropped. Many of these borrowers are still paying 2% to 3% more than the current variable rate - something that must hurt.

Today's market

Let's examine today's fixed rate environment. The market believes that rates are on the way up - thinking reflected in the current fixed rate offers. Take a took at this table showing the interest rate premium you'd pay as compared to current variable rate loans:

(Rates as at 2 September 2009)

So, if you chose a three-year fixed rate loan, you would be paying an additional 1.5% to 2% now on your repayments, ahead of when the market believes rates will go up. While the variable rate remains cheaper than the fixed rate, this could mean that during the fixed term period you'd be paying a lot more for your home loan in return for certainty about your repayments.

In other words: if variable rates go above the fixed rate, you win. Yet, if variable rates stay below the fixed rate, you lose.

The cost of fixed rate loans is determined by the market's view on likely moves in interest rates. If the view is that rates are going to decrease in the future, fixed rate loans will usually be less expensive than variable rate loans. If the view is that rates will rise in the future, fixed rate loans will usually be more expensive than variable rate loans - as they are today.

This view, however, can change fast depending on a range of domestic and international factors. It's difficult for financial experts - let alone your average punter - to predict with certainty which way interest rates are travelling, by how much and when.

This is why taking out a fixed rate loan with the idea of saving money can be dangerous. If you get it right, that's good for you. If you get it wrong, the consequences can be disastrous. The question is: do you want to gamble with such a big financial obligation?

What to think about

Before signing on for a fixed rate loan, you should consider the following:

1. Be certain as to why you're choosing this option - be sure you understand how a fixed loan will support your financial and lifestyle plans.
2. Prepare a budget (see our article Five Steps to creating your budget) and compare home loan scenarios to examine the financial effect of signing up for a fixed rate loan.
3. Read the loan's small print and be certain you understand the financial consequences of getting out of the loan before the fixed period expires.
4. Check with the lender to make sure the rate will be honoured while they process your loan. Time can pass between when the fixed rate is advertised and when your loan is ready to settle - be certain that the advertised rates will be locked in.

Are you a first home buyer or are you looking for a loan? Compare the great range of home loans offered by our lender partners.