To fix or not to fix (your interest rate)
Should you fix your interest rate, go with a variable rate or split your home loan?…
One of the most common questions I’m asked by clients is whether they should fix their interest rate. It’s a question that can cause much confusion and is often a topic of debate as people gather for barbeques and dinner parties.
Adding to the confusion and anxiety around the decision of whether to fix or not is the current financial climate. The Reserve Bank of Australia (RBA) is holding the cash rate at a record low, yet many of the major banks have increased interest rates on some of their home loans. It’s hard to predict whether interest rates will go up or down and by how much.
Deciding whether to go with a fixed interest rate is a complex issue, there are many factors to consider. The decision is very personal as well and what’s right for you could be completely different to what’s right for your neighbour.
Never fear though, as always, I’ve got your back. Here’s my breakdown of your options:
Fixed Interest Rates
What does ‘fixed interest rate’ mean
Fixed home loans have an interest rate that is fixed for a set period – often 1, 3 or 5 years. At the end of the fixed rate term, the loan will usually switch to the variable rate offered by the lender. However, you may apply to fix it again.
Fixed interest rate home loan – Positives
- Makes budgeting easier
- Confidence & security
- Lock in a great low interest rate
Makes budgeting easier
With a fixed rate home loan, you know what you’ll be paying in interest each month, so you can plan and budget more easily than you could with a variable rate home loan. This can make a fixed rate home loan a great option if you’re worried about making repayments if your interest rate rises.
Confidence & security
A fixed rate home loan gives you the confidence and security of knowing that if interest rates rise you won’t be affected (during the fixed term).
I know that rates are extremely low now, but they’re unlikely to stay low forever. Several big banks have recently raised interest rates on some of their home-loan products ‘out of cycle’. This means that the banks have increased their interest rates even though the RBA has held interest rates at a record low for more than 2 years now.
Lock in a great low interest rate
There are some amazing deals available at the moment. Most of the banks and lenders on my panel are offering rates around 1.99% – 2.59%.
I remember when I was a teenager my parents’ and their friends were paying up to 17% interest on their home loans. Reflecting on those times puts the low rates we’re enjoying at the moment into perspective.
By fixing your interest rate now, you can lock in a low rate for up to half a decade. This could potentially save you in the total amount of interest payable, compared to a variable loan (dependent of course on how much rates fluctuate).
Fixed interest rate home loan – Negatives
- Lack of flexibility
- You won’t benefit from rate drops
- You’re kind of stuck
Lack of flexibility
A fixed home loan is less likely to offer offset accounts or extensive redraw facilities than a variable home loan. Fixed rate home loans usually cap the number of extra repayments you can make, which means you can’t pay them off as quickly as you could with a variable home loan.
You won’t benefit from rate drops
When you have a fixed home loan, rising interest rates won’t affect you for the fixed period. However, the same is true for interest rate drops. If interest rates are falling, you won’t be able to take advantage of them for the fixed term.
You’re kind of stuck
As well as we might plan our future, the reality is that life happens, and sometimes things just simply don’t go to plan.
If you opt for a fixed home loan, you’re locked in for the fixed term. You’re likely to be restricted if you find a better deal and want to switch home loans. It’s difficult to cash out for renovations. You’ll also likely be restricted if you want to change your repayment type or decide to sell your home.
Another thing consider is – What if you get a home loan with a new lender and you discover after a few months, that you don’t like that lender, you hate dealing with them? You’re stuck with them.
If you need to sell your property, move to another lender or pay off your loan within the fixed period, you could be charged a break fee.
Some of my clients say they don’t want to fix ‘just yet’ because they are waiting to see if rates will drop even lower. It’s almost like playing a game of chicken. The thing is with rates currently at historic lows, it’s unlikely that rates will go much lower. If stability and consistency are important to you and you’re happy to commit to 1-5 years, then a fixed home loan is worth considering.
Variable Interest Rates
What does ‘variable interest rate’ mean
The interest rate on a variable home loan goes up and down, depending on movements in the RBA’s official interest rate and the interest rates charged by your bank. That means the number of your home loan repayments can go up and down too.
Variable interest rate home loan – Positives
- More freedom and flexibility
- Benefit from rate drops
- Potentially pay off your loan sooner
More flexibility & freedom
Variable home-loans are more likely to have flexible features such as unlimited redraws on any additional repayments or the ability to save on interest by setting up an offset account.
It’s usually easier to switch home loans if you find a better deal, want to cash out for renovations, change your repayment type or sell your home when you’re on a variable home loan.
Benefit from lower rates
If interest rates do drop, you’ll be able to take advantage of that drop and your repayments will decrease.
Pay off your loan sooner
You could potentially pay your home loan off sooner when you’re on a variable home loan. Variable home loans usually allow you to make extra repayments, with no extra cost, and without restitutive caps on how much extra you can pay, which in turn could enable you to pay off your home loan sooner.
Variable interest rate home loan – Negatives
- Makes Budgeting harder
- Potential for mortgage stress
Makes budgeting harder
Variable home-loans can make it harder to budget. As interest rates fluctuate so too do your repayments.
When interest rates rise, your repayments will increase, and this can put extra strain on your budget, particularly if you are trying to balance raising a family with paying mortgage repayments, or if there isn’t much of a buffer between your current income and expenditure.
Potential for Mortgage Stress
If you don’t have room in your budget to accommodate rate rises this could also lead to mortgage stress. Digital Finance Analytics defines mortgage stress as being when a household’s income does not cover its ongoing costs.
Variable home loans provide flexibility and you can take advantage of any drops in interest rates. There is an element of risk involved though, so it’s important to weigh up what’s important to you, what you need out of the home loan and whether you can financially weather potential interest rate rises.
Split Home Loans
Many of my clients choose to take advantage of both options, by going for a split loan. A split loan lets you fix your interest rate over part of your home loan while leaving the other part variable. A split loan allows you to manage some of the risks of interest rate rises while still being able to make extra repayments.
So, what’s the answer?…
If you were hoping for a clear cut answer to the question of whether you should fix your interest rate, I’m sorry to disappoint you. The thing is, there is no one size fits all approach. It really does come down to, your circumstance, your finances, what’s important to you, and your goals.
It’s a big decision with significant consequences. I work closely with my clients to analyse what they want from their home loan and compare it against what the lenders have to offer, from there I put forward recommendations, so they can make an informed decision.
If you’d like to have a chat about whether to fix, go variable, or split your home-loan please give me a call or send me an email, I’d love to help you.