I have been asked many times over the last few months by my clients whether I think that they should fix the interest rate on their home loan with three year fixed rates being significantly lower than their long term average. The real question that most of my client’s are in fact asking is Do I think that interest rates will go any lower? My answer to that questions is “if only I had a crystal ball”.
Deciding whether or not to fix your home loan should really take into consideration more than just the interest rates available, although the rate is important.
Before deciding on a fixed rate home loan it is important to understand the differences between a fixed rate loan and a variable rate loan. The most obvious differences is that with a variable rate loan the interest rate charged on the loan will vary throughout the term of the loan depending on factors including changes to the official cash interest rate set by the Reserve Bank of Australia (RBA), the cost of funds to the bank, bank lending margins and competition within the banking sector. Each of these plays a part in determining what the bank charges its customers on the home loans that they offer. As banks move their interest rates up and down, so too will the interest rate on your home loan move up and down. The current general direction, and the expected direction in the immediate future, of variable rate interest rate is down.
A fixed rate on the other hand is a home loan where the interest rate is set at the commencement of the loan term for a fixed period, generally between 1 and 10 years. The most popular term being 3 years. During this period of time regardless of what happens with the abovementioned factors your interest rate remains the same and hence if the variable interest rate falls below your fixed rate you would miss out but if rises above your fixed rate you benefit.
Fixed rates are not quoted at the same as the variable rate and don’t move in line with variable interest rates. Currently the three year fixed rates are lower than the variable rates on offer, as variable rates are expected to fall. However when the variable rate is expected to increase, then fixed rates are likely to be higher than the variable rates.
So with the basics difference sorted out we can now consider the other factors which should be considered in making a decision as to fix or not fix your home loan interest rate.
Break Costs or Exist Costs:
Break costs are charged by the bank if you are required or want to repay your fixed rate loan for any reason during the fixed rate period. This includes if you decide or need to sell your home. Break costs can be thousands of dollars and are worked out using a complex calculation which takes into account, but is not limited to, the difference between the fixed rate of your home loan and current variable rates as well as the length of time until your fixed rate term expires. So if you have any plans to relocate a fixed rate loan is probably not for you.
Additional repayments:
With interest rates lower than they have been in the recent past many people are taking advantage of making additional repayments off their home loan and in the process savings themselves thousands of dollars of interest over the life of the loan, not to mention shortening the term of the loan significantly and, whilst variable rate home loans usually allow unlimited additional repayments, fixed rate home loans do not. Most fixed rate home loans limit additional repayment to $5,000 or $10,000 per year during the fixed rate period. So if you think that you can afford to make additional repayments over and above this then a fixed rate is probably not for you.
Redraw:
Most fixed rate home loans don’t allow for additional repayments to be redrawn, so unless you are sure that you don’t need the additional funds for anything else it would be unwise to make the additional repayments into your loan, if you do decide on a fixed rate home loan.
Offset accounts:
100% offset account used as an everyday transaction account against your home loan are not available with fixed rate home loans. Whilst some lenders offer a partial offset account the cost of the partial offset per month is likely to be more expensive then what it saves you.
Other factors to consider:
If you already have a home loan then you are likely to be paying less than the advertised rate or the reference rate advertised by the lender. The discount off this reference rate will depend on many factors, including when you took your home loan out. You should not assume that you will be entitled to return to this discount at the end of the fixed rate period. Some lender’s fixed rate loans revert to the reference rate and in order to be placed on a more competitive rate you will be required to pay a switching fee.
The benefits of a fixed rate loan:
The major benefit of a fixed rate home loan is that they provide certainty of repayments over the fixed rate period. For those that are nervous about taking out a home loan a fixed rate home loan can provide a period at the beginning to establish the discipline of making home loan repayments.
Many investors consider fixed rates for their investment properties as they have interest only investment loans and owner occupied debt which they are still paying down. With the three year fixed rate less than some people are receiving in gross rental yield they are happy to set and forget for a set period of time.
So fixed rate are the lowest they have been since January 1999, will they go lower? If only I had a crystal ball. If you have read the above and still consider that a fixed rate might be an option for you I would be happy to crunch the numbers for you.
The other alternative is to have both and split your home loan into a part fixed rate and part variable rate home loan. Spliting your home loan will provide added flexibility as well as still providing some certainty of repayment, bit like a bet each way on the horses.
As always if you would like to discuss your own interest rate tactics, please don’t hesitate to call or email Margaret Godfrey Mortgage Broker in Newcastle at mgodfrey@smartline.com.au