There is no doubt Interest rates have always been hard to predict & with more lenders deciding to act independently of the Reserve Bank of Australia (RBA); the task is becoming increasingly more challenging. As a finance consultant, I am constantly asked of whether a client should fix their home loan at a set interest rate or proceed with a variable option. Unfortunately I do not have a crystal ball and the old adage of ‘how long is a piece of string’ is one of the first things that comes to mind when presented with this question and I will attempt to portray why throughout this blog.
When researching for a home loan; many people seek to purely source the best interest rate possible. Although one of the main factors, it should be noted that there is much more to a home loan than just an interest rate. With numerous lenders offering hundreds of loan products, it is imperative to review each persons individual circumstance to find a product that meets their needs and requirements. I could focus on the pros and cons of fixed vs variable rates but the main objective of this blog is to ensure when a fixed rate is chosen; it is for the right reasons. There is no doubt that in a climate of economic uncertainty, cheap fixed rates are becoming increasingly attractive. With rates at an all time low, it is easy to understand why. Like all products, there are limitations and fixed rates are no different. We must be mindful of what limitations some fixed rate products hold. For example, as a general rule lenders will only allow you to make a specified amount of extra repayments on top of the minimum repayment amount annually. This will obviously affect those looking to pay down their mortgage at an elevated rate. If the sole purpose of the fixed rate exercise is because you want the best rate and you believe you can ‘beat the banks’ then I suggest you re-evaluate your approach on the situation.
Think you can beat the banks? I advise you change your train of thought. One of the key components to think about when choosing a fixed rate is to eliminate the thought process of potentially beating the bank at their own game. Banks employ a team of economists and actuaries working around the clock to monitor fluctuating interest rate patterns. They invest an astronomical amount of time and money to ensure they get figures as accurate as possible. This is by no means suggesting they do not offer great interest rates, it is merely suggesting they have a profit margin they need to adhere too and this is closely monitored. Therefore, if you are thinking you will outsmart the bank it is potentially taking a gamble; rather than investing. Fix your home loan because it suits you and the set repayments suit your circumstances. Fixed rates cancel the levels of uncertainty surrounding fluctuating interest rates and potential increased monthly repayments. This is quite a common option for first home buyers and young couples starting a family as they can manage their finances moving forward. The second main component of fixed rate options is the period chosen to fix a set rate and I shall explain why.
Lenders are offering attractive 3-5 year fixed rates which are becoming increasingly popular. Although the rates on offer are appealing to borrowers, the fixed rate option is somewhat limited in comparison to that of the variable option. Three to five years is a long time and individuals circumstances will invariably change for better or worse. Obviously choosing the fixed rate option can become two-fold so to speak; should interest rates rise you will continue to make repayments at the set fixed rate you chose; at the other end of the scale if interest rates drop, you potentially run the risk of missing out on reduced repayments. When an individual decides they want to break these terms of the fixed contract due to the fluctuation of interest rates or to change lenders, they potentially face hefty fees known as ‘break costs’. Break costs arise when a borrower wishes to switch product or repays the loan before the fixed contract is due to end. Unfortunately for borrowers, lenders cannot advise of the fees the borrower will incur until the switch of product has been effected or until the day of settlement as wholesale rates change on a daily basis. It should be noted that the borrower may incur no fee should the rates align with the initial binding contract. For this reason it is imperative to give concise thought as to the period you wish to fix an interest rate.
Once again I must stress that an individual should choose to fix an interest rate because it suits YOU and your circumstances and the ability to meet these repayments. Ask yourself the following question- If you fixed an interest rate at 5% for five years and the variable rate drops to 4% would you kick yourself? If you answered Yes, perhaps the fixed scenario is not the right option
For more information on anything included in this blog or to seek assistance with your finance needs don’t hesitate to contact me.
Matt Penny
0411 110 151