I have fixed rates 3 times in the past decade. I have been out of the money on all three occasions.
Each time the market and advice was different. And this time, there is no doubt that the country and globe is in a completely foreign state facing rough and uncharted waters.
The overarching view is that rates cannot go any lower – hard to argue with the cash rate now at 0.25% and the Reserve Bank Governor stating that this is as low as it will go. In the most recent emergency rate cut mid-March 2020, there were hardly any lenders who passed the cut they received onto borrowers.
Banks cost of capital (the money they need to raise to then on-lend to the customers) is already starting to increase. This is one of the signs that indicates that it is unlikely that rates will go lower even though we have seen some head scratching negative interest rates in Europe and Japan, however this has not served either economy well.
You need to bear this in mind that it may, part of the risk in associated in fixing.
In the past month, we have assisted in and seen the greatest move to fixed rates more so than any other time over the past decade. As mentioned last week, there are now fixed rates as low as 2.10% (2.16% comparison rate) for owner occupied debt! That’s been a saving of almost 1% in some new clients cases. We have had clients save from $5,000 to $38,000 per year over the chosen fixed rate term (assuming variable rates do not decrease/increase).
In spite of my past personal bad luck, we do recommend that you consider this. It is potentially worth speaking to your advisers or us about. What is fairly certain is that we will be in a very low interest rate environment for a number of years to come, so there is not much risk of rates rising a lot, but the gap between variable and fixed rates currently is as wide as we have seen it in 15 years.
The reason for banks offering fixed rates is partly to attract new customers, getting them to at least commit to staying with the bank for the period of the fixed loan, but also and often there is a view that over the fixed rate period, the bank will at least break even or make money. It is very difficult to see how the latter could come true in this environment, but this needs to be taken into account.
It is important to know that each borrower’s individual circumstances will be different and fixing may be a good option for some but not others.
The following is a list of 8 points for you to consider when contemplating the fixed versus variable dilemma:
- Will you lose sleep if interest rates rise?
- Will your standard of living be negatively impacted if rates rise?
If you are going to fix, start with your home loan (non-tax deductible debt) first.
For example, if the interest rate on your $500k home loan increases by 1% the cash flow impact is $5,000 p.a.
However, if a $500k investment loan rate increases by 1%, the after-tax cost of this is just over $3,000 p.a. after your tax deduction.
Therefore, you have more capacity to weather interest rate rises on investment loans. As such, you should consider fixing your home loan first.
Will you want to access the equity in the property over the fixed rate term?
Fixing your loan essentially locks you into a lender for the fixed rate period (because if you refinance / sell, you may have to pay significant rate break fees).
Will you sell the property?
If you plan to sell the property, then don’t fix as you could be up for the above fees if you sell during a fixed rate period.
Think about your ability to make extra repayments.
Typically, you should have some variable debt (i.e. don’t fix 100%).
One way of approaching this split is to think about how much you can repay, add a buffer and that will be your variable portion.
Then fix the rest.
Consider whether a ‘fixed rate lock fee’ is worthwhile.
When you fix your interest rate you receive the prevailing fixed rate at the date of settlement, not the date of application.
If fixed rates change between when you apply for a loan (or to switch) and when the loan is actually established (drawn down), you will get the different rate unless you pay a fixed rate lock fee at the time you apply.
Please speak to us about this option.
Never fix 100% of all your debt.
It is always good to have a variable portion so that you can use an offset account (as vast majority of lenders do not allow offsets to be attached to fixed rate loans).
Also, as discussed above, most fixed rate products limit the amount of extra repayments you can make whereas the same restriction doesn’t apply to variable rate products.
There is quite a bit to consider, so please reach out to us to discuss your individual circumstances.