How freakin fabulous would it be to know the future? I am sure you are the same as me, I did not see coming half the things, both good and bad, that have happened to me. No one can predict the future. The same goes for interest rates. The finance gurus can tell you what they think will happen with interest rates, but when it comes down to it, the reality can be quite different. However, with interest rates in Australia at historic low levels of 2.5%, it is not an unreasonable to ask “Should I fix my mortgage rate?” So here are some of the things you need to consider if you are thinking about fixing your mortgage rate.
The biggest benefit of fixing your mortgage rate is that it gives you certainty. Most likely your mortgage is one of your biggest expenses, with a fixed rate you know exactly what you will be paying month in, month out, during the term of the loan. But with the benefit of certainty there is a cost and here are the 4 major disadvantages that you need to be aware of when fixing your rate:
- Fixed rate loans have a higher interest rate than variable ones. The key to seeing whether it is worth it, is to figure out, how far interest rates have to rise before paying the fixed rate makes sense. For example I took a quick look and found a 5 year fixed rate loan at 5.16%. The variable rate from the same institution was 4.62%. This means that interest rates would have to increase by more than 54bp for you to ahead on a fix rate loan, let’s call that 3 interest rate rises of 25bp? Which overall does not seem completely out of the realm of possibility, especially if you are looking over a five year time frame. Quite often, the difference between fixed and variable rates is much greater than this (say 1.2%) meaning that interest rates have to rise more substantially for you to be ahead. (Also, remember, as outlined in my post ‘How to pay off your mortgage faster’ it picking the cheapest home loan is not just about the interest rate but you also need to look at the comparison rate. Click here to see that post.)
- Interest rates could fall further and you will miss out on that benefit.
- Fixed rate loans often have a ‘break fee’ if you repay the loan early, for example if you sell your house. This break fee can be very expensive (quite often more than $10,000!), so make sure you are clear on any fees before you decide to fix.
- Extra loan repayments are often not allowed when you fix your interest rate or you might be able to do so only after paying a fee. Also, extra facilities such as an offset account may not be available with a fixed rate mortgage. Click here to learn more about offset accounts.
Nothing is forever and at some point interest rates will start to rise (this not to say that they won’t go lower first). Everybody should prepare ahead of time and you should stress test your ability to repay your mortgage under higher interest rate levels. Go to your bank’s website and figure out your repayments after adding a few percent to your rate. Remember, just five short years ago, mortgage rates were around 9.5%, a big difference to the 5.5%ish most people pay now. If you are already struggling with your mortgage or you feel you would be if interest rates rise, then fixing might be a great option for you.
Other strategies you could consider include fixing part of your loan and keeping part variable. This gives you the benefit of both worlds. Or you if you don’t want to fix you could look to increase your repayments to the fixed rate level, to build a repayment buffer to guard against interest rate rises. This strategy gives you three benefits: firstly you get the benefits of staying on a variable rate mortgage (such as the ability to make extra repayments); you get used to repayments at higher rates so there is no shock when interest rates rise and lastly you have built a buffer to help protect against rate rises.
Just a quick warning, if you are considering fixing, it is difficult to get the timing exactly right. This is because the funding for fixed rate loans is different to where banks source the funding for variable rate loans. This means that fixed rates can move up significantly, long before interest rates actually increase. Also, it is hard to get the timing right because interest rates might fall further than you expect. However, if this prospect does not bother you and you prefer certainty then fixing might be an option.
The decision on whether to fix or not to fix is a very individual one. Personally, we use our offset account quite heavily, so fixing our rate is not the right decision for us, at this time. However, with rates at historic lows, and the difference between fixed and variable rates being quite small, whether to fix your mortgage rate is a question worth considering. However, as always, make sure you do your sums and talk to your financial advisor to be sure it is right decision for you.
If you would like to find out more about mortgages please click below to see the following posts:
* Please note this is for your general information only and does not constitute financial advice. Please see a financial planner or accountant to get advice specific to your individual needs