This is a question that we are asked all the time… ‘Should I fix my rate?’. This is also a question to which there is no one answer as it depends on your own personal circumstances.
Firstly, lets look at what it all means:
Fixed Rates
With a fixed rate loan the interest rate is locked for an agreed term. Typically these terms can be for anything from 1 to 5 years, though we have seen them for up to 15 years. The interest rate is guaranteed for the term of the fixed rate agreement regardless of market fluctuations. The loan is also locked in for the period of the fixed rate agreement which means that additional repayments are limited, and if you need to pay the loan out in full within the allotted time you may face substantial penalties called Break Costs. It is impossible to ascertain what these Break Costs will be as they are calculated at the time of discharge. Generally however, if the variable interest rate of the day is higher than your fixed rate there probably would not be a Break Cost. If it is lower then there probably will be. This is because the bank calculates any financial cost to them that may arise from early termination of the fixed rate term, and this is passed on to the consumer. Note that these Break Costs may also apply if you want to switch back to a variable rate product.
Pros:
- Great for people on a tight budget and who need certainty on knowing what their home repayments will be.
- Potential to lock in at a low rate if interest rates are on the rise. (Note that historically there have been very few times in the interest rate cycle where fixed rates have been below the long term average.)
Cons:
- Lack of flexibility with regards to repayments.
- In most cases, not compatible with an offset account.
- Generally, fixed rates are higher than variable rates on offer at the same time.
Variable Rates
A variable interest rate will increase or decrease in line with market forces. Normally these increases or decreases will mirror the Reserve Bank of Australia’s movements, however there have been a number of incidences over recent years where banks have moved their rates at different increments, and at different times to the Reserve Bank.
Pros:
- Greater flexibility with regards to additional payments. Now that the Federal Government has banned exit penalties for loans established after 1 July 2011 it should be possible to pay your loan out as quickly as you are able without penalty. Note that standard discharge costs of around $300 will still apply, this is normal for all loans no matter how long they have been established. Note also that the Federal Government exit fee ban does not relate to Fixed Rate Break Costs.
- Ability to establish and use an offset account or redraw facility on your loan to minimize interest expenses if you have excess income or savings.
- In most cases people are financially better off over the long term with a variable rate loan…. Unless they have been very lucky to fix their rate at the bottom of a cycle.
Cons:
- If your borrowing is highly leveraged then you could find higher loan repayments due to interest rate rises difficult to meet. This could cause financial stress and potentially result in defaulted payments.
Split loan
This is not a loan type so much as a technique used to split your loan amount into two sub accounts. One loan is fixed, and one remains variable. This then gives you the advantages of a variable rate loan with regards to additional repayments and features, but allows you to insulate yourself from interest rate rises on the fixed portion.
So, when it comes to deciding whether you should fix your loan, or keep it variable you really need to refer back to your personal circumstances. Ask yourself whether you could absorb interest rate rises? Even if you can, would you worry about it? Never discount the ‘sleep at night’ factor.
It is impossible to predict future interest rate movements as so many factors will influence this (classic example being the Global Financial Crisis), and so rather than trying to ‘beat the banks’ our best advice to you is to decide what is more important to you…. The security of knowing what your loan repayments will be, or the flexibility to pay off your loan quickly or if needed sell your property without potential penalties.
Please don’t hesitate to contact us to discuss your own situation. Note that this information is of a general nature only and should not be used to decide what is appropriate for you without further consultation with a professional.
