With the recent reduction in official interest rates by the Reserve Bank to 0.25%, procuring a loan has never looked better as interest rates reach historic lows. But for those with existing loans, knowing if it’s the right time to fix the interest rate on your mortgage or your investment loan leaves many borrowers confused. So what are the positives and negatives of fixing interest rates?
As Baby Boomers you may have memories of locking in your interest rate at somewhere around 9% only to watch the rates plummet during and after the GFC. Bound by contractual clauses and potential penalties to exit the arrangement, you quickly became aware of the downsides of fixing rates.
- When you lock in your interest rate you are contractually liable to meet the fixed rate for the term of your fixed contract, even as the variable rates fall.
- Should you break your contract before expiry, you may pay early repayment penalties if the interest rate at the time of cancellation is less than the rate at which you fixed your loan.
- Most lenders enforce limits as to how much extra you can pay off your loan in any one year – the maximum is usually $10,000 – $30,000 per annum. If you receive unexpected windfalls, say bonuses etc, you can’t reduce your loan more than $10,000 – $30,000 per annum, making it difficult for you to pay your loan down faster.
So why fix?
- Historically, fixed rates have been set at higher rates than whatever the prevailing variable rates were, due to uncertainty about what will happen in the future. In the past, therefore, it was more of a gamble to fix your rate as the market needed to move up for you to gain the financial benefit of fixing.In recent times however, fixed rates have generally been lower than the variable rate. Therefore, if the variable rate doesn’t move over time you may benefit from the lower fixed rate. Fixing is, therefore, less of the “gamble” than it once was.
- As your mortgage is usually your largest monthly expense, fixing your loan could help you to plan your cash flow.With interest rates at an all-time low, the risk of penalty, should you decide to terminate your contract is reduced. However, if at the time you wish to terminate your contract, if the prevailing rate for the remainder of your contract term is lower than where you fixed, a prepayment penalty will apply. But with rates now at historic lows there is potentially less risk that you will attract a prepayment penalty.
With interest rates currently at an all time low, there may possibly be room for a further drop. Logic would suggest that we are approaching the end of the low interest environment, but without a crystal ball we cannot predict where interest rates will end up.
So what should YOU do?
Fixed rates offer some certainty regarding cash flow during the fixed period. Yet variable rates permit us to make additional repayments without penalty while having access to a non-penalty redraw facility should you need access to cash in future. Of course, borrowers with variable rates will always benefit should rates continue to fall.
The key is to remain proactive. Setting and forgetting can cost you money and unnecessarily extend the term of your loan and your action plan should include:
- A review of your finance arrangements every couple of years. Competition in this sector is strong and it can be to your advantage.
- Consider splitting your loan between a fixed and variable rate. Providing you are unlikely to sell the underlying property within the fixed rate term, a mix of fixed and variable rates could provide the best of both worlds. That is, greater certainty of cash flow (fixed) and flexibility (variable). The percentages of the mix will depend on your individual circumstances.
Now is the time to consider all possibilities.
Talk to your bank, accountant or to us. We help you to consider the impacts of interest rates on your overall financial position and with a long history in the banking and lending sector. We are well placed to provide guidance appropriate to your overarching circumstances, please accept my invitation to give me a call on (07) 3251 3201.