To fix or not, that is the question?
Amanda Varidel, Managing Director of Heart Mortgage Services explores whether it is the right time or have you missed the boat.
We all know interest rates in Australia have recently been at their lowest levels ever, even in spite of the recent RBA cash rate increase by 25 basis points. Speculation has been developing amongst analysts and economists about the potential for rate hikes this year and beyond.
So, if you’re looking to take advantage of low-interest rates and are unsure about whether to go for a fixed rate or variable rate, we’re going to explain how they differ and let you know what Amanda has to say about your options.
First up the basics:
Fixed-rate home loan A fixed-rate home loan is a home loan that has an interest rate that does not change for a fixed term. This provides repayment security and means that even if interest rates in Australia do rise, the interest rate and repayments on your fixed-rate home loan will stay the same.
That’s good for the budget. It’s important to be aware that the ‘fixed’ period is not the duration of the loan but an agreed starting period usually around 1-5 years. After the fixed term, you will need to re-fix a term at a new rate or move to a variable rate, as your rate will likely automatically revert to a variable one.
Fixed-rate home loans do tend to be less flexible. It can be harder to make changes so options like large extra repayments, accessing redraw, having the functionality of an offset account or refinancing during the fixed term may not be available, restricted or costly.
Variable-rate home loans A variable home loan has an interest rate that varies – it changes over time. This means your variable home loan interest rate will fluctuate in line with the variable home loan rates set by the lender and your repayments may go up and down in cost as well.
However, for borrowers who look for a variable-rate home loan, you sacrifice budgeting uncertainty for flexibility and features you may miss out on with a fixed-rate loan. Features such as lower fees, offset accounts, redraw facilities and the ability to make lump sum repayments as and when you wish are appealing to many borrowers opting for variable-rate loans.
Split: Part fixed & part variable home loans If you think you want features from both variable and fixed-rate home loans then split-rate home loans are worth a look. Depending on your circumstances split home loans are an option that may allow you to have one part of your loan repaid as a fixed home loan with a fixed rate of repayment, and the other part repaid as a variable home loan with its variable interest rate.
For example, for a $300,000 loan, you could have a 50/50 split, where 50% of the loan ($150,000) is charged on a fixed interest rate and the remaining 50% of the loan ($150,000) is charged on a variable interest rate.
In this situation, you may be able to enjoy the security of a fixed rate on one side and enjoy functionality such as additional repayments on the variable rate part of your home loan.
What do we say?
We have done a lot of analysis on this over many years, and we have never seen a period where fixed rates actually outperform variable rates.
So, if I take a fixed interest rate today and a variable interest rate today, and I analyse its performance over five years, the variable rate always outperforms [the fixed rate]. In other words, you pay less interest over a period of time.
For borrowers who currently have a variable rate home loan or are about to borrow money and have the option of a fixed or a variable interest rate product, we believe it’s an “emotional decision”.
If you want to be absolutely sure that your monthly repayments are going to be ‘X’ dollars a month for 5 years, get a fixed rate product, and whether rates go up or down, you’re hedged if you like, you’ve locked in your monthly dollar value of repayments.
There are sometimes some hidden costs in that, for example, if you want to pay in more than your set repayments, sometimes there is a penalty to do that, so they don’t have the flexibility of a variable rate. Whereas a variable rate is affected by capital markets and what central banks do. While we are reasonably confident about our outlook for interest rates, sometimes something comes along. For example, no one forecast coronavirus coming along and rates being cut two years ago.
If you’re happy for that monthly repayment to be an exact dollar amount for 5 years, you’re fixed, you know its ‘X’ dollars coming out of my pay every week, every month. Good! If you want flexibility, or you think you’re going to get a bonus or you think you’re coming into a bit of cash, and you can make a repayment on the principal on a variable rate, that flexibility is also worth something to a lot of individuals.
If you are nervous about applying for a variable rate home loan, with the predictions of rate hikes this year or next, and you want some certainty, consider a split-rate home loan.
Basically, you have a bit of each product. You have a foot in each strategy camp, and it can help you sleep at night. At the same time, you can make an extra payment, and pay off the variable part of your home loan without facing a penalty.
Considering your circumstances?
Throughout 2021, there were a lot of 2-year fixed rates on offer below, at or around a 2%. The year before, many lenders offered 5-year fixed rates slightly higher than those levels. Now there is a commentary about future interest rate increases, but the capital markets are already built this into the cost of fixed-rate money.
This means that currently, you would be lucky to find a 3-year fixed rate under 4.5% and a 5-year fixed rate can be as high as 7.5%!
So, if you opt for a fixed-rate product right now, you are effectively paying a significant premium over the most competitive variable rates available, for the certainty of fixing.
Whether you are shopping for the best home loan or looking to refinance, you need the facts. It’s always in your best interest to engage with us before you make a decision, so please reach out to us today to discuss your options by calling 1300 861 143.
Your Choice Mortgage Brokers Pty Ltd ATF Halo Innovation Trust trading as Heart Mortgage Services - Australian Credit Licence 38643.
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