With Australia currently enjoying historically low interest rates there are many borrowers asking themselves “should I fix the interest rate on my loan?”
Indeed at many BBQ’s and social functions across the country the topic of interest rates is often raised and it seems that there are many views and opinions on the best strategy, which just adds to the confusion for many of us.
An important point here is that no one can accurately predict what will happen with interest rates in the medium to long term. There are just simply too many economic variables that can influence interest rates and that makes predicting movements with any certainty an impossible science. You only need to look at variations of opinions of qualified economists in interest rate movements over a six month period to understand the difficulty in predicting rates 1, 3 or 5 years into the future.
So I would personally treat anyone telling me with absolute certainty what will happen with interest rates with extreme caution.
In the current low rate environment we are seeing 1 to 5 year fixed interest rates at historically low levels and even hearing financial institutions make comments that they have never offered such low rates. In fact many lenders appear to be promoting low fixed rates as a tool to build market share in a subdued loan market, by targeting those existing borrowers looking to refinance.
But there are both pros and cons in fixing your loan interest rates.
The main benefit is a fixed interest rate gives you certainty in your repayments and therefore your household budgeting. You know what your repayments will be each fortnight or month for the period your rate is fixed. This is particularly attractive if household finances are tight and any upward rate movement could have a detrimental impact on borrower’s lifestyle choices.
However there are also elements of fixed rate agreements that may not be so attractive including:
- If interest rates fall you may be left making loan repayments at a higher level than many other borrowers.
- There may be penalties with repaying or refinancing fixed rate loans before the expiry date of the fixed term. These penalties are normally at their greatest when interest rates have fallen since committing to a fixed rate. So before considering a fixed rate take into considerations your plans over the next few years (i.e. will you be looking to sell and relocate?).
- Many loan features such as Loan set off accounts or redraw facilities may not be available for fixed rate loans, reducing the overall flexibility of the loan.
- Additional or voluntary loan repayments can be restricted for fixed rate loans. So if you are looking to rapidly reduce your loan you may be restricted in your ability to do so. It is not uncommon for any additional repayments to be restricted to say $10,000 p.a., but each lender is different and if this is important to you, makes sure you do your research.
Variable Rate loans generally offer greater flexibility but as their name suggest the rate can move at the discretion of the lender. Historically rate movements were aligned to Reserve Bank (RBA) changes in the cash rate. However over recent years we have seen many Banks adjust rates independent of RBA changes as they attempt to manage their own cost of funds and broader market impacts.
Like fixed rates, there are currently some very attractive discounted variable rates on offer in the market by lenders attempting to build market share.
In falling interest rate environments borrowers with variable rate loans can experience reductions in their interest rates and therefore repayments reducing, but similarly, as rates increase variable rate borrowers incur additional repayment costs each time interest rates are increased.
The main benefit of variable interest rate loans is that borrowers normally can expect greater features and flexibility. So if aspects such as being unlimited in the level of additional repayments you can make along with having loan set off and redraw facilities are important, then chances are you will find the terms of variable interest rate loans more attractive.
Borrowers who see the benefit in both fixed and variable rates options may consider a split loan.
A split loan simply refers to splitting your loan between part fixed and part variable loan options. Effectively borrowers have two loans with one being fixed and the other being variable.
Under such scenarios it is recommended that borrowers consider any additional costs in holding two loans rather than just one and still ensure they are aware of all conditions of the fixed rate component.
So, should you consider fixing the interest rate on your loan?
The simple answer is that there is no ‘one size fits all’ response to this question. Before making a decision your individual financial position, risk appetite, preferred features and future plans should be taken into consideration.
Certainly in the current environment there are many who would consider the fixed rates on offer as worth thinking about, but committing to such a decision should only be made after careful consideration of your personal position.
Your local Loan / Mortgage Broker or Credit Adviser can provide assistance in working through the options on offer and help you establish what will suit your personal circumstances.