Do Savings On Fixed Rate Loans Surpass Variable Rate Loans?

Do Savings On Fixed Rate Loans Surpass Variable Rate Loans?

Is Now the best Time to Fix
Your Home Loan Rate?

The interest rates on offer in Australia now are the lowest they’ve ever been, which is sparking a lot of people to not only review what their lender is charging them, but if they don’t get a better deal, refinance to a better rate. Also, a lot of people are looking to take this opportunity to lock in a historically low fixed rate.

Who can Blame Them?

There are any number of lenders offering fixed rates below the 2% benchmark for owner occupied home loans, and any number of lenders offering around the 2.5% mark for interest only investment property loans.

Frankly, I’ve never been a fan of fixed rate mortgages, because I’ve seen too many people get burned by them. You know, the going rates are around the 6-7 percent mark, there’s a lot of media hype (mostly engendered by the lenders themselves) about interest rates going up.

So, like a lot of blind sheep we rush in to our bank and fix our interest rate. Of course, the lender rubs their hands together in glee, quietly thinking to themselves that you’re not going to be going anywhere fast for the whole of the fixed rate term.

Then over the next few months to our horror and anguish we watch interest rates start to fall while we remain stuck up there on the high interest rate shelf.

I agree, that doesn’t necessarily happen all the time, but it does happen. My philosophy has always been that if you maintained a competitive variable rate you would always be ahead of the game.


‘However, in this current market you have to start questioning yourself’.

Where are Interest Rates Going to go from Here?

The Reserve Bank of Australia (RBA) has cut the official wholesale rate to 0.15%. Will they cut rates any further? It’s difficult for me and most others to imagine they would.

Additionally, most lenders are not passing the rate cuts on anyway, claiming a variety of excuses. The main one being, any rate cut is going to affect the rates they deliver to their depositer customers.

Before we go any further, let’s be clear and quickly recap what the difference is between a fixed and a variable rate. So a variable rate is going to go up and down, depending on two things: one, what the lender does with their individual policies and two, what the Reserve Bank of Australia does with their official cash rate.

Do You Prefer a Bit of Predictability in Your Life?

A Fixed rate, on the other hand, is going to give you certainty over the interest rate for a given period of time. Now most lenders will allow you to fix for up to a maximum of five years. That means for those five years your interest rate is not going to change, regardless of what the RBA does to the official cash rate.

As with everything in finance, there are pros and there are cons of fixing interest rates, the pros in this case are fairly obvious.

First of all, you’re going to protect yourself against future interest rate increases and also you’re going have better certainty on what your cash flow needs are going to be.


There are Restrictions You Should Know About!

However, there are a number of downsides to fix interest rates which we need to consider. In the unlikely event the Reserve Bank decides to lower interest rates, you will not benefit from the reduction in interest.

Plus, most lenders have restrictions on how much extra you can reduce the principal balance of the mortgage by over a given period of time. e.g. pay off an extra $5,000 or $10,000 for each year of the fixed term.

This can be very restrictive for those people who are serious about getting out of debt.

Additionally, most fixed rate lenders won’t allow you to have an offset account against your fixed rate mortgage.

Are You an Offset Account Fan, Listen Up?

If you have been reading some of my previous blog posts you would know that I’m quite a fan of ‘offset accounts’ as they essentially provide a risk-free, tax-free return equal to the interest rate on your mortgage, which is way better than any savings account in today’s market.

The good news is, there are a limited number of lenders out there that do offer an offset account with their fixed rate loan products. To me, that’s an awesome feature if you can also get a low rate to go with it.

Don’t be Fooled!

Although, be aware there are two types of offset accounts. These can be described as non-transactional and transactional.

Non-transactional, allows for any money deposited into the offset account to offset against your mortgage balance and save on interest charges. However, if you want to utilise any of that money to pay bills, B-Pay, ATM withdrawal, etc. you have to transfer the required amount over to a normal bank account.

That can be a hassle for some, not so much an inconvenience for others.

Transactional offset accounts allow you to access any deposited funds freely. They operate like a normal bank checking/savings account. The main benefit being convenience. Because, while you have instant access to your funds, any amount left sitting in the account offsets against your mortgage balance, saving you on interest charges.

The other negative to watch out for are partial offset accounts; For example, the lender might say that you can have an offset account, but only 30 or 40 % of the funds held in the offset account will offset against your mortgage. Substantially reducing any savings you will make.


I Heard You can be Slapped with Penalties, Right?

Many people avoid fixed rate loans because they are concerned about penalties they may incur if they break the fixed term contract, in the event they want to sell their property or refinance their mortgage. Therefore, they would only ever consider fixing if they believed their circumstances weren’t going to change for the fixed term of the loan period.

There’s good news here too, as most lenders offering fixed term loans that have the offset account feature have removed those types of restrictions. Meaning, you can pay off as much as you want, whenever you want.

Something to consider that a lot of people haven’t thought about is, when you fix a loan you are essentially betting against the bank. The bank will set the fix rate above or below the variable rate, depending on where they see the official cash rate headed.

Consequently, if they believe that the official cash rate is going up, then they’re going to put the fixed rate above the variable rate, because they anticipate that the variable rate is going to rise. If they think the official cash rate is going to fall, then their fixed rate is going to be below the variable rate, because they believe that the variable rate is going to fall.

Now, I don’t know about you, but the idea of betting against people who have billions of dollars invested in getting this call right is a little daunting to me. Fixed interest rates are currently low, deliciously low and it seems they are going to be staying that way for some time to come.

What are the Experts Saying About Interest Rates?

Or, more accurately in this market, interest rates are going to stay at the current low levels for an extended period. Most financial experts that I monitor seem to be of the same opinion.

Thus, I like the flexibility that you get from a fixed rate loan with an offset account, which you just don’t get from the mainstream fixed rate loans. I like the ability to make extra payments. I like the get out of the contract feature and I especially love the offset account.

You get the best of all worlds, interest rate predictability, cash flow stability, offset savings and possibly a good nights sleep as well.

Not Sure Which Way To Go, Hedge Your Bet?

In as much as you can’t decide what’s better for you fixed or variable, or your preferred lender doesn’t offer a fixed loan with offset feature, then why not take a split approach? This is where you fix a portion of your loan amount and you leave the balance as variable.

(Split Loan Calculator)

By doing this, you’re essentially hedging your bets. You’re going to get the flexibility that comes with a variable loan (with offset) and you’re going to get the certainty that comes with a fixed loan. Over time, one of them is going to work out more beneficial for you. Depending of course, on what the cash rate does and on what happens in your personal circumstances.

For anyone who’s keen on a fixing later approach, I suggest they may want to try the hybrid approach, part variable and part fixed. I’m sure you can tell by now, I’m wasn’t a big fan in the past of fixing a mortgage, but with owner occupied fixed interest rates under 2% I no longer have those reservations, go for it!

Whichever way you do decide to go, don’t just get sucked in by the lowest, interest rate possible, consider the features of the loan and how that ties in with your financial goals.

Retain the services of a seasoned trustworthy mortgage broker who will take the time to explain things to you, do the calculations and candidly tell you what your best options are as opposed to just telling you what you want to hear.



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Discover How To Increase Your Borrowing Power

Discover How To Increase Your Borrowing Power

Do You Know Your Borrowing Power?
Learn How To INCREASE It!

Weightlifting strongman squating with heavy weight

The Essential Borrowing Power Guide

When you’re looking to purchase property, refinance to a better rate or release equity from your home, one of the first steps you should undertake is to find out what your borrowing power is, or how much your lender is willing to lend you.

Here, you’ll learn what is meant by your borrowing capacity, what impacts it and how it’s calculated. Then we’ll provide you with four tips on how to improve it.

By the end of this article, you’ll have a better understanding of what you might be able to borrow and how you can potentially increase your borrowing capacity.

However before we start, if you’re also into getting other savvy home loan tips about Australian mortgage products, you can go to our home website and take a look around. If you’re into saving money and getting ahead financially, it’ll be time well invested.

What is borrowing power?

So, how is borrowing power calculated? Although the exact criteria will differ from lender to lender your borrowing power will be calculated based on the following:

How Does Cash Flow Add Up to Strong Borrowing Power?

Your income is one of the most important factors when calculating your borrowing power. Your current and future income situation indicates to the lender how you are going to be able to meet the ongoing nature of the repayments?

Income used for borrowing capacity purposes can be derived from multiple sources such as employment, rental, income dividends or other investments.

Whatever income is being used, the lender will want to confirm the ongoing and sustainable nature of the income source, your asset and liability position, as well as ongoing and other living expenses.

You can access our free borrowing power calculator here.

Will Your Assets and Liabilities Tip the Scales?

A strong financial position shows your ability to handle money and expenses. If you own enough assets or have sufficient equity in your property, you will be able to use this equity as collateral and can also increase your borrowing power.

If you have little to no existing debt and a high asset position, you’re more likely to have a much higher borrowing power than someone with much more debt and a lower asset position.

E.G Even if you have a credit card with a $0 balance that you pay off each month with a high limit, the lender will still use the limit in order to calculate your borrowing power.

You see, as far as they are concerned your capacity to borrow against that credit card limit is viewed as a liability to them. They’re worried you’re going to jump on a cruise liner tomorrow and run the credit card balance up to the limit in the ships casino (lol).

Are You a Spendaholic?

Expenses are broken down into both discretionary and non discretionary expenses. Discretionary expenses are expenses that can be changed, such as eating out at nice, restaurants and lifestyle expenses.

Non discretionary expenses are the mandatory expenses that need to be paid back each month. For example, a non discretionary expense can be something like insurance or childcare, or even groceries, Something that must be ongoing and paid back each month.

If your lifestyle expenses are high, this could in all likelihood impact your ability to borrow, and in some circumstances you may even need to justify some non-discretionary living expenses and the ongoing nature of these outgoings.

Understanding the Importance of the HEM Protocol

In today’s residential/consumer lending market lenders have to observe and comply with the National Consumer Credit Protection Act (NCCP) or responsible lending act.

The main benchmark for this policy is measured against what is known as the Household Expenditure Method (HEM). This pre-determined benchmark amount will have an impact on your borrowing capacity.

There are varying benchmarks used for the number of people in your immediate family circle. E.G. you’re single, you’re a couple, your single with kids, you’re a couple with kids etc.

The more people that are in the immediate family circle means the higher they will judge your regular living expenses to be. Therefore, the (HEM) has pre established higher benchmark amounts for each size group.

Of course, you can debate whether you fit the mold, but if you’re under the pre-determined benchmark, then you have to come up with a practical explanation.

When Was the Last Time You Saw a Copy of Your Credit Report?

Last but not least, your credit history will also impact your borrowing power significantly. If you want to get an estimate of how much you can borrow use this link to access our free borrowing power calculator.

What can you do to help increase your borrowing power?

The best way to increase your borrowing, power and chances of credit approval are to indicate to the lender that you’re financially sound and can meet your loan repayments.

A simple way is to get rid of unnecessary debt and credit cards. How much debt you currently have will influence your borrowing power to a great extent. Having unnecessary debt, such as credit cards that you don’t even use could significantly deter a lender from the amount they’re willing to lend you.

Another way is to reduce your expenses. Lenders want to know that you can comfortably meet your repayments and if they sense you might be living week to week and could be at risk of mortgage stress, this can significantly affect your borrowing power and even your ability to get approved for any loan.

How Good a Money Manager are You?

Looking up the curved driveway to a nidely restored residential home

It’s smart to regularly review your expenses and see if you can cut back on any non discretionary expenses such as the gym membership you never use.

Be aware, in today’s regulatory mortgage market banks take a very close look at how much net money you have coming in and how much of that you have going out.

They have terms like NSR (net servicing ratio), DTI (debt to income ratio).

The bottom line is, the lender will take close note of what your net income is (after tax and any other compulsory deductions), from that they will subtract your living expenses and your financial liability repayments. Then they will take a hard look at what you have left as well as the ratio of your debt to net income percentage.

Many can be left scratching their head, because even though they have a good income, have never defaulted or have never ever paid late on any loan, but they still get declined.

It’s good idea that you review your financial position and adjust it to your best financial advantage before divulging any of your financial information to a prospective lender. Seek out an experienced mortgage broker to help you with this.

What Does Your Savings Track Record Say About You?

Having a good savings history indicates to the lender that you are financially sound and if your circumstances do change in the future, you have a much higher chance of being able to meet the ongoing nature of the repayments.

At the same time, if you are purchasing property the larger the deposit equals the less amount you’ll need to borrow.

What Importance do Lenders Put on Credit Scores?

Lastly, you want to be aware of and try and improve your credit score. Your credit report is a reflection of your credit history and includes things such as all inquiries you’ve had, for any credit, as well as any hardships such as defaults.

Having an adverse credit history or a bad credit score can significantly reduce your borrowing power, as it indicates to the lender that there’s a much higher risk of default on the loan.

What is considered a Good Credit Score?

You will find that any credit score can vary depending on which credit scoring model you are using. Generally though, if you score between 580 to 669 that’s rated as fair; If you end up between 670 to 739 that’s rated good; from 740 to 799 you’re getting into the very good marker; from 800 and up is rated as excellent.

You can get a free credit score report here

If you want to learn more about credit scores contact a knowledgeable mortgage broker.

There you have it, the essentials you need to know about borrowing power and the four tips you can use to help increase yours. If you’re looking for more great tips click through to our main home website page and fossick around where we talk all things home loans. We hope you have found the above helpful…

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