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.
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.