Do you fix it or keep it swinging?
The vexed question surrounding home loan interest rates
With interest rates at a record low and tipped to start increasing over the next few months, is it time for you to start thinking ahead?
The RBA has kept interest rates on hold for the last 17 months with a cash rate of 1.50% - primarily to ease the Sydney and Melbourne overheated property market, lower than target inflation and the slow Australia job and wage growth.
Compared to some countries such as United Kingdom, USA and Japan, there is still room for the RBA to further reduce the cash rate. However most chief economists believe the cash rate will start to increase towards mid-2018 due to factors mentioned above.
Whatever direction rates move, it may be a good time to investigate what a rate rise will look like in terms of your mortgage repayments. Most banks offer the following rate types to suit your circumstances:
As the name suggests, a fixed rate locks in an interest rate for a specific period of time. In times where rates are uncertain, fixed rates start to look appealing.
Advantages – Fixed rates give the borrower certainty of their repayments for a specific period of time and allows you to be more accurate with budgeting. Most banks offer fixed rates from one to five years. In addition to the certainty, fixing in could mean that you are paying lower than the increasing variable rate which saves you money over time. Disadvantages – Locking in your interest rate means that you could miss out on potential rate reductions. Fixed rates are also quite rigid as with most lenders you cannot make overpayments or have access to an offset or redraw accounts. Also if you wanted to close down your loan, where, for example, you sell your home, you would be hit with a penalty which can be thousands of dollars.
A favourite for many borrowers due to the amount of flexibility a variable rate offers. Variable rates sway up and down depending on market forces like what the RBA cash rate is, and individual banks’ competitiveness/margins.
Advantages – Variable rates allow a great deal of flexibility for borrowers as you can make extra repayments without any penalties. Most banks will also offer a redraw or offset account which allow you to save money in a transactional account linked to the mortgage, however have full access to it. If your lender isn’t competitive in the market place, you can switch loans to another lender, penalty free. And of course, if interest rates reduce, so do your mortgage repayments.
Disadvantages – As the rate can increase and reduce, it does not allow borrowers to budget effectively. More importantly variable rates can put borrowers at risk should rates start to increase.
There is some middle ground for borrowers who like the sound of both as most lenders will allow you to fix part of your loan whilst keeping the remaining on variable. The advantages and disadvantages are as above, where it allows borrows to have some certainty on part of the loan however also have the flexibility of making overpayments, accessing the cash and benefitting from rate reductions.
Fixed rates are especially suitable for borrowers who cannot budget an increase in interest. However, they are only suitable for borrowers who do not have any plans that may affect their home loan within the specified period of the fixed rate due to the penalty.
Variable rates are suitable for the less cautious borrower along with borrowers who can make overpayments in order to pay down sooner. This rate type can also save you on interest during times where rates are reducing, however can catch out borrowers with unexpected rate increases.
Deciding on which way to proceed in terms of your loan structure can prove to be a gamble. However, for borrowers who cannot budget a rate rise, fixed rates may prove worthwhile, irrespective of interest rates reductions. Although you may have missed out on a saving in interest, fixed rates are designed to give the borrower comfort of known repayment amounts of the biggest financial commitment most borrowers have.
Speaking to a mortgage professional may not only allow you to save thousands in interest but also allow you to structure your loan to suit your current and future requirements.
Raj Ladher from Tomorrow Finance is a mortgage expert with over 11 years' experience both in the UK and Australian mortgage markets. Accredited with the Mortgage and Finance Association of Australia (MFAA) and access to numerous lenders, Raj specialises in all types of mortgages, from first homeowners to investors increasing their portfolio. For more, email firstname.lastname@example.org. au