As the Reserve Bank of Australia’s cash rate continues to hover at a record low 0.1 per cent, many borrowers are asking themselves if it’s time to fix their rates.
If you’re a first-time borrower, you may be wondering what you need to know about fixing an interest rate and why not everyone is doing it.
Let’s explore the pros and cons of fixed vs variable interest rates and when is the right time to fix it.
What is a fixed interest rate?
If you’ve been doing some reading you may have come across the term fixed interest rate or standard variable interest rate.
A fixed interest rate is an interest rate that is locked in and won’t move for a certain period.
It could be one year, two years, four years, or five years.
It’s usually a package offered by the bank as an enticement to lock in customers.
Don’t make the mistake of thinking the bank’s interest rate is the same as the Reserve Bank of Australia’s cash rate.
They are two different things.
But they are related.
The banks set their interest rate (the rate you pay) based on the cash rate set by the RBA.
When do you lock in a mortgage rate?
While thinking about when you lock in a mortgage rate, the other important aspect is why you would fix it.
For some, it makes sense, they are starting a family, reduced incomes, or hedging in the case of many of our property investors – all very valid reasons.
With the world still battling a coronavirus outbreak and share markets and businesses around the world displaying considerable volatility amid extremely unpredictable operating conditions and sustained record low-interest rates, it’s understandable that the topic of interest rates has taken centre stage once more.
The cash rate sits at a microscopic 0.1 per cent there’s nowhere else to go if financiers want to offer incentives, so the banks have shifted their focus to fixed-rate options as a way to lure borrowers through the door.
The market has seen some very aggressive moves with fixed-rate offerings over the past six to 12 months.
At one point, you could actually lock in a fixed rate lower than the variable rates.
Unheard of before now.
And most variable rates begin with a 2.
So, should I fix it?
Making the decision to fix is one that many homeowners struggle with over the years as they watch the nightly news with intense concentration waiting for the finance news and the RBA’s decision.
For many, it’s a vexatious question and they’re always wondering, ‘when do you lock in a mortgage rate?’.
If the RBA is lowering rates, the question many ask themselves is, ‘Should I fix my home loan now, or wait to see if interest rates fall further?’.
For many homeowners, uncertainty prevents them from deciding, or from seeking expert advice.
The economy is uncertain, both here and overseas.
Half the country is, once again, in lockdown and while the property market is performing strongly for the moment, it’s very difficult to forecast how it will cope with these latest lockdowns or what the future holds with vaccination rates, labour rates, or inflation.
Will we return to some semblance of normality quickly, or slowly?
These factors will all play a role in what will happen with interest rates moving forward.
As a result, it’s difficult to predict what the banks will do with the fixed mortgage rate offers.
At Intuitive Finance, our recommendations are never around “rate chasing” as such.
Sure, what interest rate you lock in is very important as it directly correlates to how much your mortgage payment is every week/fortnight.
But there are other factors that are equally as important.
Know the risks
I’m always keen to discuss with clients the risks associated with a fixed mortgage rate.
We were recently introduced to a new client who wanted our assistance to get out of a fixed rate.
‘Why’, you ask?
Well, they went into a bank branch and were sold onto a very low rate – in fact, fixed for three years at less than 3 per cent.
However, the clients also had a significant cash savings amount sitting in their offset account and by fixing their rate they lost the benefit of that offset balance – something that was not explained to them by their banker.
Even with the very low fixed rate, the clients were actually losing money due to the loss of the offset account.
What a horrible outcome for them.
So here are the main things you have to be aware of when fixing your interest rates:-
You may lose the benefits of having an offset account
You may lose the ability to make lump sum reductions to the loan
Any rate cuts in future won’t affect the fixed rate that you have
You will likely be unable to switch to another lender without incurring significant break costs
You may not be able to take the next step in your investing process as you are bound to that single lender’s rules
So, for these reasons, you need to consider carefully why you might want to fix your interest rate.
The main advantage of a fixed rate option is the rate and repayment certainty.
This, for many people, does outweigh the above risks or disadvantages and allows them to go about their normal daily lives with that security.
This makes it clear about the best time to lock in a mortgage rate.
I hope that helps answer the question, ‘Should I fix my home loan?’.
Consider all options before fixing
There are some great variable rate options on offer at the moment and it is worth tackling some homework to understand what each of the main lenders is doing before committing to one lender’s fixed-rate option.
Now, don’t get me wrong.
If circumstances align, then I’m not against you fixing – in fact for some of our investor clients who were in the right circumstances, we have locked in a fixed mortgage interest rate.
But it is important to make an educated, informed decision rather than simply rate chasing.
What if you move to a low fixed loan provider and then in one, two or three years’ time they won’t assist you with what you want to do?
Can you split your loan?
Splitting the loan is the next thing to consider and this is where people can start to get strategic and have the best of both worlds.
Imagine having all the flexibility of a variable rate loan with your offset account and the ability to make extra repayments as well as the rate security of the fixed-rate loan.
This is a great option for many people and one that is now becoming more favourable in the current low-rate environment.
It means having two loans – one fixed and one variable – but this way you can take advantage of both low-interest rates and rate certainty as well as the flexibility of all the features of a variable rate loan as well as the potential for future rate cuts.
How long can I lock in a mortgage rate?
So, we’ve answered the question, ‘what is a fixed interest rate’ and, ‘can you split your loan’ and now you’re keen to move to the next step.
If you have decided to either fix your rate or split your loan, the next question you may be wondering is how long can you fix it for?
Generally speaking, the banks will offer a period of between one and five years.
In rare cases, some lenders may allow a borrower to lock in for 10 years.