To fix or not to fix? That is the question on the lips of just about anyone looking to take out a home loan. It doesn’t matter which lender you choose, or whether you’re an investor or owner-occupier, you have a choice. Will I opt for a home loan with a variable rate or fixed rate?
There is no right or wrong answer, although there are often clear reasons why one is likely to be more favourable in your circumstances.
The reason for this murkiness is that interest rate movements are unpredictable and out of your control. Local and global economic forces determine what happens to Australia’s official cash rate, which is set by the Reserve Bank. Lenders generally follow the Reserve Bank’s lead when setting their interest rates, although market forces (mainly competition from other lenders) can ultimate decide what rates they offer to customers across a range of lending segments.
So, what do you need to consider when assessing the option of a fixed rate home loan?
What is a fixed rate home loan?
This is a loan in which the interest rate stays constant for a set period – perhaps one, three or five years. How long the loan is fixed will vary depending on what the lender is offering at that time and your needs. After the fixed-rate period is over, the loan will generally revert to a variable rate – unless you choose another fixed-rate period.
Fixed rate home loan offers generally have different headline interest rates to those with variable rates. Sometimes they are higher; sometimes they are lower: and they will often be different depending on the length of the fixed period.
Overall, the level at which a lender sets its fixed rates will depend on how aggressive it wants to be in trying to attract new business for a particular home loan deal. It also indicates where the lender believes Australian interest rates will be heading in general. When the fixed rates being offered are lower than their variable rates, it suggests lenders think rates may fall (or at least be steady) in the short to medium term.
What are the advantages and disadvantages of fixed rate home loans?
Fixed rate home loans offer one sure thing to borrowers: certainty. Regardless of what is happening with interest rates – especially if they look like they might be heading up – you’re shielded from having to pay more in your monthly mortgage repayments.
Paying a set amount in regular intervals helps you plan your household budget easier, and possibly allow you to put some money aside for future renovations, personal treats or your business. Over the fixed-rate period of your loan, you know exactly how much you will need to put aside for your mortgage every year.
On the downside, fixed rate terms make it much harder for you to pay off the loan faster. Many fixed rate loans don’t allow you to pay very much (if anything at all) from your loan principal. Some fixed rate loans don’t offer redraw or offset facilities. If you choose to change from a fixed rate loan to a variable option, you are likely to pay expensive “break costs” (see below). This is especially troubling for those who choose (or are forced) to sell their property.
The biggest shortcoming of fixed rate home loans, though, is that you’re unable to take advantage of any fall in interest rates that would allow you to pay lower regular instalments. In these circumstances, you don’t have the option of making the same repayments and putting extra money towards your principal, which would increase your level of equity in your home.
Is it a good idea to fix your home loan?
This is a tough question to answer. You need to consider your own circumstances and the state of the economy.
It’s usually better to fix your rate when the economy is stable. During these times, especially when stability is matched with relatively subdued inflation and unemployment levels, interest rates are likely to remain lower than what’s considered “normal”. The opportunity during these times is that a fixed rate could protect you from any future increases brought about by growing uncertainty or volatility.
Of course, choosing to fix your mortgage when interest rates are already relatively high might save you money. It might also put you in a position that can be compromising or even potentially disastrous.
Many people choose to fix their loan in these circumstances because they think that interest rates will continue to climb. They want to lock in their costs before interest rates get even higher, and their monthly repayments rise. Doing this, though, may prevent them from taking advantage of lower rates once the economy stabilises. It may also force them to pay relatively high regular interest payments for the term of their fixed loan.
It’s notoriously difficult for anyone – even financial experts – to pick the top and bottom of the interest rate curve. What we do know, though, is that the trend is cyclical. Just as you will never have a choice of historically low interest rates forever, you can also be sure that relatively high interest rates will begin to fall at some stage.
Where interest rates have tracked in the past should certainly not be guide to where they may head in the future. You can read our 2017 bulletin on whether now is the right time to fix your interest rate for more insight.
How long should you fix your mortgage?
This will depend on what lenders are offering – how competitive their interest rates are – and your personal circumstances. For instance, if you believe that you’re likely to sell your home within the next five years, it would be unwise to take out a five-year fixed loan. The expensive break costs would likely outweigh any savings you might make on a lower interest rate.
There is no rule of thumb when it comes to determining the period of a fixed loan. You just need to remember that the longer the length of the fixed-rate loan, the less certain you can be on where interest rates will be when the term ends.
What are the break costs?
Most loans have some kind of “discharge fee” that covers the lender’s cost of removing the mortgage from the title registry. But lenders have an extra special – and generally very hefty – fee for discharging a fixed rate home loan. This “break cost” – which your lender might call a “prepayment fee”, “early repayment adjustment” or “early termination fee” – is likely to run to many thousands of dollars.
This is certainly a factor when you’re weighing up variable and fixed rate loans. For example, if you’re looking to sell your home in the near future you’re likely to be better off with a variable rate loan, not a fixed rate loan. The same applies if you wish to make bigger repayments or refinance your home. Even worse is if you’re forced to default on your loan – you will also likely be told to pay a break cost.
Your lender will determine how much you will be charged to break your fixed-rate home loan. You’re likely to pay much more if interest rates have fallen since you took out your loan. Other factors are how much you still owe on your loan and how long you had left in your fixed-rate period.
As always, you must check the terms and conditions carefully before agreeing to any fixed-rate term. (See here for more about the cost of breaking a fixed rate home loan.)
That said, in some circumstances, it may still be cheaper to refinance your loan and pay a break cost than continue paying off an expensive fixed-rate home loan. The best idea is to book a call with our customer care team today to discuss your options.
Which fixed-rate lender should I choose?
Most lenders offer a variety of fixed rate loans for investors or owner-occupiers. This is because every lender looks at the market in its own way. One may think interest rates are preparing to spike. Another may see the rate going down. Some may wish to grab a larger proportion of customers from a certain market segment.
This means you’re unlikely to find the best loan for you if you approach just one lender or mortgage broker.
It’s wise to seek out what all lenders are offering. Just be mindful of not racking up too many enquiries on your credit report.
Better still, book a call with our customer care team today to work out which loan is the best one for your circumstances.
How flexible are fixed rate home loans?
Most traditional fixed loans have very little flexibility. That said, in recent years more lenders have been building some flex into their fixed-rate home-loan offers.
Some of these newer fixed-rate products have the following:
- The option to pay interest only (although this is generally not a good idea). Even investors are better off paying the principal and interest on their loans.
- The ability to make more payments without incurring break costs. Some offer this as a fixed yearly amount or up to a certain percentage of the loan.
- Offset and redraw options.
- Lower fees for maintaining the loan.
What is a rate lock?
Those applying for fixed rate home loans also have to keep changing rates in mind. It’s possible for a lender to change their fixed rate in the time between a borrower applying for their loan and having it accepted.
If this happens, borrowers are forced to take the new rate. Should the rate increase, this places the borrower in a worse position that they bargained for.
This is where “rate locks” come in. Many lenders allow you to pay a fee to lock in the rate that is offered to you at the time of application. Such fees range from $400 and $700. Some lenders prefer to charge a percentage of the loan, perhaps 0.15%, to protect you from any rate changes during the application process.
Most rate locks last for 90 days. Also, you can’t get one if you’re at the pre-approval stage.
For many, a split mortgage is an attractive option. This allows you to segment your home loan into smaller parts that are subject to different repayment criteria. This means you can get some of the benefits of both fixed and variable rate mortgages.
A split rate home loan is not a product itself. It’s a feature on a home loan package that a lender may offer. Lenders allow you to carve up your mortgage how you like – it does not have to be a 50/50 split between fixed and variable rates. This gives you better control over how you manage your day-to-day expenses and mortgage repayments.
See here to read more about split mortgages.
What to do next
Fixed rates offer protection against changing interest rates. They also prevent you from taking advantage of such changes if interest rates fall. As such, they offer stability that sometimes comes at a cost.
What you choose to do will depend on your situation. A fixed loan may work for you if you can make the repayments comfortably and you want the loan to remain stable. Just bear in mind that you might end up paying more in interest than those on variable loans.
Email us at email@example.com before making any decisions.
This information is general in nature and you should always seek professional advice when making financial decisions.
This information in this article is general only and does not take into account your individual circumstances. It should not be relied upon to make any financial decisions. UNO can’t make a recommendation until we complete an assessment of your requirements and objectives and your financial position. Interest rates, and other product information included in this article, are subject to change at any time at the complete discretion of each lender.