Australian borrowers have been enjoying a sustained period of low interest rates.
Since the Reserve Bank of Australia started reducing rates in November 2011, we have had a steady reduction of official cash rate from the high of 4.75%pa in 2011 to the 1.5%pa we are enjoying as at March 2018. It is common in Australia for the bank lending rate to be approximately 2%pa to 3%pa higher than the official cash rate.
There remains a level of speculation as to whether interest rates have further to reduce or may indeed start to rise, but for now we are still experiencing record low rates.
Loans in Australia give the opportunity for the borrower to either remain on a variable interest rate, that can move up or down depending primarily on Reserve Bank announcements, or lock in an agreed interest rate for periods up to 10 years.
It is never an easy decision on whether or not to fix your interest rate on your loans, so we have put this quick guide together to assist you in assessing your options
What is a fixed rate loan?
Almost all property loans in Australia offer the opportunity to be on a fixed rate for a nominated period during the loan term.
A Fixed Rate Loan simply means that you have the option to agree a specified interest rate that will not change for a selected period, usually between 1 and 5 years. As such, once fixed, your interest cost will not move even if the market variable rate does.
Fixing your loan assists with budgeting and also protects you against future rate rises.
If you feel rates are likely to rise, you may choose to fix in order to shield yourself from the increases. However, this works both ways as rates can move in either direction.
Here we consider the potential issues, both positive and negative of choosing to fix your interest rate.
Shielded against rate rises
By fixing at the right time you can save on future rate rises.
In certain economic conditions, today for example, rates seem to have bottomed out and are currently at historical lows, so therefor it would be reasonable to think that they will move closer to the historical average and begin to rise sometime in the future.
By fixing your rate now, you are protected as your selected fixed rate will not increase even if the variable rate does. Had you chosen not to fix and remained on a variable rate, then any increases are passed directly to you by the bank.
Assists with budgeting
Repayments are set for the fixed rate period, which can make it much easier to plan your financial affairs.
A fixed rate will ensure that your mortgage repayments do not increase regardless of any upward movements in interest rates.
Ability to Split Your Loan
Most lenders permit you to have a mix of both fixed and variable on your full loan by splitting the loan into different components.
This way you can have some of your loan with an assured fixed rate while some remains variable and get the best of both interest options.
Exposed when Rates Drop
The flipside of the first positive. When rates drop you’re left with the higher rate, paying a premium.
Ending a fixed contract early can be expensive in certain situations. It can cost in the tens of thousands as the bank is entitled to charge the interest differential on the prevailing market rate over the remaining term of the loan. It should be noted that if rates have gone up there may not be any cost to break as the bank can deploy the funds at a higher level.
Break costs create inflexibility. Therefore, if you need to sell or refinance, you’re not in a position to do so. So, if your circumstances change and need the equity in the property you can’t won’t be able to sell until the fixed period is over.
In contrast to variable loans you can only make a limited amount of extra repayments per year. Generally, it’s limited to $10,000 – $20,000 per annum at each bank, so if you were considering extra repayments be sure to split your loan to allow this to occur against a remaining variable portion.
Lenders only offer 40% offset accounts. 40% offset is an inefficient use of funds so it’s not worth it.
Situations where it’s a good idea
Set and forget investment
For investors, using a fixed rate loan can be a wise move in this climate because you keep your cost of funds set for the fixed rate period and do not need to be concerned with your interest costs increasing.
Balanced Income & Expense Budget
If you’re in a situation where your income is just meeting your living expenses, then a fixed rate option can ensure your repayments the same regardless of interest rate movements. It provides a high level of comfort knowing that your main expense, the family mortgage, will remain unchanged for an extended period.
If you’re intending on having kids in the near future and servicing the loan on a single income, it could be an advantage to fix your home loan. This will ensure you don’t have concerns or any expensive surprises if rates rise during the lower family income phase.
If you have concerns about your future income stability or personal circumstances, a fixed rate can provide the protection of a certain cost in uncertain times that could prove to be very valuable and give great peace of mind. Importantly, if you felt that you might need or want to dispose of the property, then fix only for the period up to the likely sale so you do not get unwanted break costs on the loan.
To arrange a free review of your current lending options from Specialist Mortgage email [email protected] or visit Smats.net/finance.
Article by Jeremy Doney of SMATS GROUP: Australian Property, Tax & Finance Experts since 1995.
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