DON’T GET TALKED INTO A 5 YEAR FIXED RATE

While it sounds like a good idea to fix your interest rate if there is a historical low, generally speaking those who fix their rates pay for it in the long run. That’s essentially what a fix is; trading opportunity for the security of knowing what the interest on a home loan is for a set period of time.

So you pay a price – but is it a reasonable one?

I recently received a phone call from two different clients with a similar story. They both felt cheated by previous brokers who were ill informed, part time – so called subject matter experts. ‘stitched up’ were the exact words of one client, who found his broker through recommendations in a community chat thread.

To sum up his scenario, this particular client was very unhappy with his current loan set up. The broker he used last year recommended he fix his loan for 5 years at 4.60% – What I would call day light robbery and a perfect example of when a broker puts his interest before the clients and enters misleading and deceptive conduct territory. Unfortunately this happens too frequently, sometimes unintentionally and other times not so much.

It will cost the client $7,500 to break the fixed term loan but after doing a cost vs benefit analysis he will save at least $8,500 overall. Had the loan not been fixed for such a long period, there would be opportunity to save more.

While it sounds like a good idea to mitigate risk, there actually isn’t that much interest rate risk these days. We are no longer in the late ’80s when rates moved from 10 – 17 per cent in a year. Interest rates are very likely to be contained in a fairly narrow band over the next two to five years.

As you have gathered, I am not a fan of fixed rate mortgages as it can limit flexibility, especially 5 years which is essentially tying you to the lender. If you need to borrow more for example, you’ll have to go to your provider. And again if you want to move home, you’ll be beholden to your existing lender to let you take the loan with you. When the RBA lowers the cash rate, it means that homeowners who have a variable interest rate get a huge opportunity to pay off their loans more quickly. The same opportunity won’t apply to those who have fixed their rates, and who are now locked in to a certain amount for a fixed period of time.

Although a variable rate on a mortgage bond means that the buyer has to be flexible with their monthly budget, it is generally considered to be a better choice than a fixed rate option. Understandably a fixed interest rate means that at least one of the items of expenditure in your household budget is certain and the bank positioning it 25-50 basis points less makes it all the more attractive but you also pay a significantly higher rate than the variable rate straight away, so you are putting yourself behind the eight ball from day one. To recover that immediate loss, official rates have to rise very rapidly. Which they rarely do.

When I come across clients who are adamant they want to fix their loan and it makes sense to do so, I would always only encourage 2 years and careful consideration for any more. 2 years is a perfect amount of time and sub consciously we see it like our mobile phone plan, which can make it more digestible.

Remember, it’s important to take into account your future plans when considering whether or not to fix your home loan. If you think you might want to sell or refinance your home in the next few years then it’s probably not a good idea to fix as you’ll have to pay break costs.

At the end of the day, no one can predict with any real certainty where interest rates will go. If you can afford to weather the peaks and troughs it may pay to stick with a variable loan and hope for the best.

If you are looking for a second opinion on your home loan please feel free to call on 03 8390 5855 or email mitesh@thinkandgrowfinance.com.au