08 February-2017

Is it time to fix your mortgage?

The RBA Cash Rate is currently at historic lows, and expectations for an increase are low. In years gone by, fixed rate mortgages have been several points higher than variable rate mortgages, but we are now in an environment in Australia where fixed rates are comparable and even lower than variable rates This presents a unique position where you could insure yourself against future interest rate rises at a low comparable cost.

So, when is it right to go for a variable rate over a fixed rate?

There are a few key factors to consider:

  1. How long you’ll want to hold the loan or property for.
    • Any changes can cost you big to break a fixed rate
  2. The cost of fixed and variable rates
    • Quite simply, what can you save?
  3. Your ability to repay debt
    • Fixed rates have limits

In the past, to fix the interest on your loan, you would normally pay a premium on top of the variable rate of the day, suggesting that interest rates are due to rise. Now that the fixed price is in fact lower than the variable, you could argue that variable rates are due to drop. However this will only be a reality if the RBA drops their rates first (or the banks start competing fiercely for new clients), so anything could happen!

So for this case study, I want to look at three scenarios using the following criteria:

  • $250,000 loan size
  • Fixed rate of 4%
  • Variable rate of 4%

Rising variable interest rates

Obviously, being in the fixed rate will be cheaper in this instance. For every 0.25% increase, the variable rate will cost you an extra $625 each year (interest only) – effectively “saving” you that amount in interest. By fixing, you avoid this additional cost and potential worry.

If you are in a fixed rate, a good strategy here is to try and make the extra payments you would otherwise have to make if the loan were variable, and try to cut into your mortgage!

Falling variable interest rates

The opposite applies here and the potential savings you are missing out on could be a large factor if there were many interest rate cuts.

Here’s where it can be difficult. If the rates are falling, are they falling enough to warrant you breaking your loan to secure lower rates? Unless the rate drops are large and you are struggling to maintain your payments, then generally no.

Consideration must be given to whether the benefit of a lower rate justifies the cost to get it. The strategy here is to look very carefully at what you are currently paying against the price to exit and how long it would take to save that money (based on what you now save on interest) – and whether you WILL actually save that money. This is where a good finance advisor can be the difference.

Paying more into the loan

The last scenario involves some number crunching. Let’s look at a situation where you have $50,000 to put into that $250,000 mortgage. In the case of a fixed rate, you have a limit of the additional repayments you can make each year (in many cases it is capped at $10,000), so it would take 5 years to put this cash into the mortgage. After 5 years the fixed rate would most likely have matured, however let’s assume that it hasn’t, and the variable rate remains largely unchanged.

Had you paid that additional $10,000 into the fixed rate evenly over the 5 years against paying $50,000 into the variable loan straight away, at the end of the five year period, the variable rate would have saved you over $4,5000* in interest alone, and this can compound if those savings are further paid into the loan.

Remember of course that this is a very isolated case and there are ways to counter this such as:

  1. Put the additional money into a term deposit, and then you can offset the interest you are paying (although you will pay tax on the interest you receive which lessens its impact)
  2. Initially setup your loans with part fixed, part variable. This allows the extra repayments (or an offset account) to allow for these types of situations.

So, should you fix?

In the past, Getaloan has been very strong on only fixing if you want certainty of repayments, however right now fixed rates are at lows, and barring economic problems, they could well be below variable rates for a while yet. So we do believe now is a great time to look into fixing a portion of your mortgage and potentially use the savings to pay down your variable loans quicker.

* Note:  The figures used in the above case study are illustrative only and do not take into account your own personal financial situation and does not constitute financial advice. A full breakdown of the figures is available upon request.

Enquire Now

Enquire Now