Fixed Interest Home Loans.. is now the right time?
The simple answer is that there is never a clean cut yes or no answer to this one!
It may not be the quick answer that most are looking for. However a decision on whether to lock in a fixed rate for all or some of your home loan is one that should be made in full consideration of your unique financial situation. One critical question that you might need to ask yourself is this:
Can I afford to accept a certain degree of risk?
By going with a set rate you protect yourself from any rate rises that you would otherwise have had to absorb if you decided to go with a variable home loan rate. This is a big plus when weighing up the advantages of a fixed rate home loan. There has never been complete certainty around which way interest rates will move over time. The fact that our banks are adjusting their rates increasingly independently of the Reserve Bank of Australia only adds another layer of uncertainly around whether rates will decrease or increase over the coming months and years.
If you are in a situation where a sudden rate rise might stretch the purse strings too much you may well save yourself a considerable degree of stress by locking in a fixed rate.
How likely is it that rates will continue to fall or rise?
It would be absolutely sensational if we could get our hands on the crystal ball that reveals all about what the future has in store for our interest rates. The reality is that we just do not know. What we can do though is look back at what has happened in the past to give us clues about what might happen in the future.
Hindsight is a wonderful thing – consider these past scenarios;
Who can remember a time where rates edged up around 17% and kept climbing? When this was happening people were in a mad rush to lock in a fixed rate around 15% which seems ridiculous to us now – but in the context of what was happening at the time could well have been considered the safe thing to do. Within a year rates were under 10% much to the frustration of those who had fixed their rate around 15% for 5 years!
The most recent sharp interest rate increases were generally and widely not predicted by any of the experts. These sudden interest rate rises in both August 2007 and also around October 2009 caught many off guard and unfortunately in a difficult financial situation.
What I am trying to convey is the fact that things can change quickly and this has certainly been true on a number of occasions. You need to protect yourself – especially if you are in a situation where any sudden rate increases could put you in a spot of bother!
Don’t variable rates generally cost less over time?
It is a valid point that if you look back through the past decades it is invariably (excuse the pun) true that most will have ended up paying less if going with a blanket variable rate approach as opposed to going with a blanket fixed rate approach.
What needs to be considered in the context of our current markets is that fixed rates are being offered right now at historic lows. This reduces the chance that you will miss out on too many more significant variable rate reductions. Most lenders right now are offering 3 year fixed rates at around 5.39% and 5 year fixed rates at 5.69%. Both these rates are well below the long term averages and therefore we are recommending to most clients that they consider fixing some part (not necessarily all of it) but some into these historically low rates. These rates are the lowest seen in over 20 years and the risk of €losing out’ on many further significant variable interest rate cuts is at an historical low.
Taking this into consideration alongside the high degree of uncertainty surrounding local and global economic conditions leads many to the conclusion that the safe thing to do may be to fix the interest rate in their home loan, or at least fix a percentage of it.
So what is the downside to a fixed interest rate?
Cheap fixed interest rates do seem attractive in this climate, but the security and level of certainty that they provide do come with some downsides. There are typically limitations with fixed rate loans that generally do not apply to variable loans such as;
Changing your terms during your fixed rate period generally comes with a price
€ many lenders have exit fees associated with fixed rate terms that may not be applied to variable loans
€ Most banks don’t allow an offset facility with fixed rate loans
€ You can’t make additional payments (some do allow between $5k and $10k per year)
€ You can’t redraw any additional payments that you may have been able to make
When considering these drawbacks, it is why we often €blend€ or €split€ a client’s loan into 2 parts. Some fixed to take advantage of the very low rate and then some variable to enable us to take advantage still of being able to make extra payments, have a redraw facility and/or an offset account. Splitting our loan often gives us the best of both worlds.
I do again, however, need to emphasize that everyone’s circumstances are very different and therefore the amounts that we consider on the €splits€ can often differ.
What should you do?
It all comes down to your personal financial situation. While €letting it ride’ on a variable home loan rate may be advisable for someone in a comfortable situation who can absorb a considerable amount of risk, the same might not be true for someone with not as much scope to increase their home loan payments to accommodate any significant interest rate rises.
With fixed Melbourne home loan rates approaching historic lows it is, at the very least, time for all of us to consider the structure of our home and investment loans!