Interest rates in Australia are the lowest they have ever been which is sparking mortgage holders to not only review their rate, and potentially refinance to a lower rate, but many are also looking to fix their interest rate to lock in a good deal.
With fixed interest rates as low as 2.09% on owner-occupied and 2.34% on investment, who can blame them?!
But are fixed interest rates all they are cracked up to be and is now the best time to fix? Well, let’s have a look.
Variable vs fixed
Before we jump into it, let’s quickly recap what the difference between a fixed and variable interest rate. A variable interest rate will go up and down depending on the lenders policies and the cash rate which is determined by the Reserve Bank of Australia (RBA).
A fixed rate on the other hand gives you certainty over your interest rate for a set period of time. Typically, you can fix an interest rate for up to 5 years and during those 5 years your rate won’t change regardless of what the RBA does.
Is fixing your interest rate a good idea?
As with everything in finance, there are pros and cons to consider before deciding to fix your interest rate. In this instance, the benefits are obvious – by fixing your interest rate you protect yourself against potential future interest rate increases which also helps to stabalise your outgoings for cash flow management and budgeting. This is definitely a “sleep well” factor for many people.
Also, fixed rates are currently cheaper than the average variable rate. Like I mentioned before, one of the better fixed rates on the market currently is 2.09% and a good variable rate is 2.59%. It is not always the case that fixed rates are lower than variable rates but, in this market, it is.
However, there are a number of downsides to fixed rates which include:
- If interest rates drop, you will not benefit from the reduction in interest
- Fixed rates generally won’t allow you to have an offset account against your mortgage. For anyone who has been following me for a while you will know that I am a big fan of offset accounts as they essentially provide a risk-free, tax-free return equal to the interest rate on your mortgage which way better than any savings account.
There are a few lenders out there that will let you have an offset account against a fixed loan, which is awesome, but many who do will only give you a partial offset. So for example, the lender might say you can have an offset but only 40% of the funds held in the account will be used to offset your loan.
- Fixed rates generally have restrictions on how much additional repayments you can make towards your loan. For many lenders, they will only allow you to make an additional $10,000 in repayments, above the minimum, per year. This is very restrictive for those people wo are serious about getting out of debt.
- If you break your fixed term contract because you want to sell your property or refinance your mortgage, penalties will apply. You will be charged a fee for not seeing out the fixed term contract. So you would only ever consider fixing if you believe your circumstances won’t change materially for the duration of the fixed loan.
So there are some pretty big downsides there to consider but let’s consider one more that people might not have thought about. By fixing your interest rate you are essentially betting against the bank.
The bank will set their fixed rate above or below the variable rate depending on where they see the official cash rate headed. If the market anticipates that the official cash rate will rise, fixed rates will become more expensive because lenders assume variable rates are likely to rise in the future. If the market believes the official cash rate, and hence variable rates, will fall in the future, fixed rates will become less expensive.
Now I don’t know about you but the idea of betting against people who have billions of dollars invested in getting this call right seems a little daunting to me.
What should you do?
Fixed interest rates are currently low, deliciously low. But that doesn’t mean they couldn’t get lower. If your whole reasoning behind fixing an interest rate is to get the lowest rate possible, then I would advise against it because you are betting against some big players.
Also, I like the flexibility that you get from a variable loan which you just don’t get with a fixed loan. I like the no lock in contract, I like the ability to make extra repayments and I especially like holding my cash in an offset account.
On the other hand, if you want that sleep well at night factor and need stability in expenses then sure, a fixed loan might be for you.
The split approach
If you still can’t decide what is better for you – variable or fixed – then why not take the split approach. This is where you fix a portion of your loan and keep the other portion as variable.
By doing this you are essentially hedging your bets. You get the flexibility that comes with a variable loan and the stability that comes with a fixed loan. Over time, one loan is going to work out more beneficial than the other, depending on what happens in your particular circumstances and what happens with the cash rate.
For anyone who is keen on a fixed loan I almost always try to steer them towards this hybrid approach as I have seen fixed mortgages detriment people way too many times!
My final thoughts
So as I am sure you can tell by now, I am not a big fan of fixing your mortgage BUT I do understand that it is appropriate for some people.
Whichever way you decide to go, don’t just get sucked in the by lure of the lowest interest rate possible. Consider the features of the loan and how that ties into your financial goals.