Image by Wayhome Studio via Adobe Stock
Image by Wayhome Studio via Adobe Stock
To fix or not to fix? That is the home loan question plaguing borrowers now that home loan rates at historic lows. So is now the time to “lock it in, Eddie”?
- Fixed vs. variable home loans
- When is it a good idea to fix your home loan?
- When is it a bad idea to fix your home loan?
- Is now a good time to fix your home loan?
- What about split loans?
- What to consider before fixing your home loan
With home loan interest rates the lowest they’ve ever been, many Aussies buying a home or thinking about refinancing are probably wondering if they should fix their mortgage now to protect themselves from potential future hikes. So we put the question to Mortgage Choice CEO Susan Mitchell: are more borrowers fixing their home loans in the wake of recent cuts?
“No, we have not seen more borrowers deciding to lock in their interest rate. Our home loan approval data shows that demand for fixed-rate home loans has dropped since the RBA’s back to back cash rate cuts in June and July,” Ms Mitchell told Savings.com.au.
“This isn’t entirely surprising when you consider that there is intense speculation in the media about another cut to the cash rate before the end of the year. Fixed rates may be priced very competitively at the moment but the prospect of even lower variable rates is too good to pass up. I suspect that borrowers are happy to ride the variable rate wave for the time being.”
With that in mind, should you fix your home loan now? Or should you wait for rates to fall even further? Should you even fix your home loan? Should you just stick with a variable home loan? Should I stop asking twenty questions and just get on with it?
Should you choose fixed or variable rate mortgage?
What is a fixed home loan?
As the name suggests, a fixed home loan has an interest rate that’s fixed (it doesn’t change). A fixed home loan has the option to lock in (or fix) your interest rate for a set period of time (usually between one and five years). At the end of the fixed term, the home loan will revert to a variable rate, often the lender’s ‘standard variable rate’.
The biggest advantage of fixed home loans is cash flow certainty. Your repayments will stay the same for the set period of time. Fixed home loans are popular with property investors in particular because it controls their cash flow and keeps their interest repayments higher which minimises tax deductions.
The inflexible nature of fixed home loans is both a blessing and a curse. Because the rate is ‘locked in’, fixed home loans are less flexible for a number of reasons. If home loan interest rates drop, your fixed-rate will stay the same. Fixed-rate home loans can also attract large break costs if you break your contract before the fixed period ends, possibly to the tune of thousands of dollars. Fixed-rate home loans also typically don’t allow you to make extra repayments, and if they do it usually comes at the expense of a hefty fee. This means you’re limited in the speed at which you can pay off your home loan. Sometimes, it can even be more expensive to take out a fixed home loan than a variable one.
For example, take a look at these fixed rates:
Base criteria of: a $400,000 loan amount, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. The product and rate must be clearly published on the product provider’s web site. Introductory rate products were not considered for selection. Monthly repayments were calculated based on the selected products’ advertised rates, applied to a $400,000 loan with a 30-year loan term. Rates correct as at 17 February 2020. View disclaimer.
What is a variable home loan?
Variable home loans are largely influenced by the official cash rate set by the Reserve Bank of Australia (RBA). This means your interest rate can rise or fall over the life of the loan depending on what happens with the cash rate, among other things. Most Australians choose to finance their home with a variable rate home loan because of the flexibility and freedom they offer.
One of the biggest benefits of taking out a variable home loan is that you’re able to make extra repayments on top of your scheduled ones with no penalty. By making extra repayments, you can reduce the length of your mortgage which reduces the amount of interest you’ll pay.
Another huge benefit of variable home loans is if the cash rate drops and your lender decides to pass on the changes to its customers, you will have less interest to pay off. Conversely, if the interest rate goes up, so do your repayments.
The biggest drawback of variable rate home loans is the level of financial uncertainty associated with them. Because variable rates are tied to the cash rate, the amount of interest you need to pay is at the mercy of the economic conditions outside your control. Lenders can even raise your variable interest rate in the absence of a cash rate hike (known as an out-of-cycle rate hike). So your repayments are likely to change over the course of your mortgage which can make it challenging to stick to a budget.
For example, take a look at these variable rates:
Base criteria of: a $400,000 loan amount, variable, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 75%. The product and rate must be clearly published on the Product Provider’s web site. Introductory rate products were not considered for selection. Monthly repayments were calculated based on the selected products’ advertised rates, applied to a $400,000 loan with a 30-year loan term. Rates correct as at 17 February 2020. View disclaimer.
When should you lock your mortgage rate?
The answer from Ms Mitchell is simple: “When it suits your existing financial situation and your overall financial goals.”
“Fixed-rate home loans are a good idea if you want certainty for your home loan repayments because you might be dealing with budget constraints or foresee a change to your cash flow and you want more control over your finances,” Ms Mitchell said.
So if you’re the type of person who likes the certainty of knowing exactly what your rates and repayments will be over the next two to five years, fixing your rate could be worth considering. Similarly, if you’re on a shoestring budget and worried about how you’d cope if rates increased, a fixed home loan may be tempting.
Otherwise, Ms Mitchell said many borrowers make the mistake of chasing the lowest rate without stopping to consider other rate features.
“I think we often fall into the trap of chasing the lowest interest rate and while it’s an important part of the decision when choosing a home loan, lender policy, loan structure and features should not be overlooked. For example, a borrower may benefit from a redraw facility or an offset account, features which come at a cost but could be beneficial to the borrower over time. It’s worth noting as well that not all borrowers will qualify for the lowest rate on the market.”
When is it a bad idea to fix your home loan?
While fixing your rate gives you repayment certainty, there are times it can backfire. If you lock in your rate and home loan interest rates start falling, you’re stuck with the rate you locked in at until the fixed-rate period expires. This is where an economic crystal ball would really come in handy!
Fixing your rate is also a bad idea if you don’t want to be stuck with a particular lender or home loan product. Ending your fixed-rate period prematurely incurs high exit fees, sometimes to the tune of thousands of dollars.
If you want the option of being able to make extra repayments on your home loan, a fixed rate might not allow you to do that. If you manage to pay off your loan within the fixed-rate period, the lender may charge you exit fees.
Fixing your home loan could also be a bad idea if, during the fixed term, you’re planning on selling your home or renovating it using equity from the property.
Is now the time to fix your mortgage rate?
Hang on a sec, let me just whip out my economic crystal ball…
All jokes aside, it’s not so much a question of ‘is now a good time to fix, it’s a question of ‘is now a good time for me to fix’. Regardless of what may happen with interest rates, you need to decide whether fixing is the right thing for you based on your short and long-term goals.
Ms Mitchell said borrowers should only take out a fixed home loan if it’s the best option for their financial situation.
“Borrowers should consider their long-term financial needs before locking in to a fixed-rate home loan because these home loans require a borrower to sign a contract and commit to locking in an interest rate for an agreed period. Borrowers need to know that they may incur break costs if they wish to make extra repayments, refinance or switch a fixed rate home loan before the fixed-rate period expires,” Ms Mitchell said.
“If you do decide to make this commitment over one to five years, you should have a clear motivation for doing so. Ask yourself, are you choosing to fix because you need repayment certainty over a set period of time?”.
So if it’s repayment certainty you’re after, fixing your rate may be worth considering – regardless of what interest rates are doing. The good news is that right now, lenders are offering some excellent fixed interest rates. In many cases, there are better deals to be had with fixed interest rates than with variable rates.
What about split loans?
If you can’t decide between fixed or variable, why not just have the best of both worlds? You could hedge your bets by fixing half of your loan and leaving the other half variable. This is what’s known as a split loan.
A split home loan isn’t actually a type of home loan, it’s a type of home loan interest rate. Where most home loans are either variable or fixed, a split home loan is good if you’re a bit indecisive because you get a part fixed, part variable interest loan.
With a split loan, you essentially split the balance of your home loan into two accounts. One is charged a fixed interest rate while the other is charged a variable interest rate – at different portions. There’s pretty much no limit to the way you can split the loan, so you can allocate the funds 50/50 or 20/80 – whatever you like.
Splitting your home loan means you can take advantage of both types of rates. In the current low-interest-rate environment, having more of your loan as a variable rate means reaping the rewards if rates keep falling. Conversely, fixing a greater majority of the loan will be beneficial if interest rates rise.
Things to consider before fixing your home loan
Even though fixing your rate can be tempting for the risk-averse among us, ironically, taking out a fixed home loan can actually be a bit of a gamble. That’s because you’re essentially making a bet with your lender over whether interest rates will go up or down. Get it right and you win by avoiding a rate hike. Get it wrong and you miss out on a rate cut and the lender wins by default.
Before you fix your rate there are a few things you should keep in mind:
1. Interest rate movement
At the time of writing, interest rates are at historically low levels and are likely to continue falling.
While you may be tempted by some of the great fixed rates there are right now, what seems like a good deal now may not look as good compared to rates in six or twelve month’s time. By then, fixed rates may be as low as 2.50% or even less. Will you still be happy that you locked in your rate when it was at 2.89%?
Fixing your home loan is not that dissimilar to wagering a bet with your lender over whether market interest rates are likely to go up or down. Keep in mind that lenders price in the likelihood of future rate movements when setting their rates, so may the odds be ever not in your favour. You can’t beat the banks at their own game!
2. Expensive break fees
If you do decide to fix your rate and later decide you want to refinance because you’re fed up with paying a higher fixed rate than the lower variable rates on the market, you’ll be stung with a hefty penalty. Breaking your loan before the fixed-rate period ends amounts to exxy break fees, often to the tune of thousands of dollars.
Break fees also apply if you decide to sell your house or pay off the loan before the fixed-rate period ends.
3. Revert rates
Don’t assume the lender will do you a solid and revert your loan to the bank’s lowest variable rate once the fixed-rate period ends. Instead, the lender will probably just put you back on whatever their standard variable rate is – which can often be quite a bit higher than some of their lowest rates.
Frequently asked questions
1. How common are fixed rate mortgages in Australia?
Just about all lenders in Australia offer both fixed and variable-rate mortgages. The most common fixed rate mortgages in Australia are one-year to five-year fixed rate terms, with few lenders offering 10-year fixed rate terms, and even fewer offering 15-year terms. A 30-year fixed rate mortgage is not available in Australia.
2. Is a variable rate of a home loan always higher than a fixed rate?
Not necessarily. As variable home loan rates can rise or fall depending on what's happening in the market, variable rates may not always be higher than a fixed rate. You'll find that the average variable rate is actually usually lower than the average fixed rate.
3. Can I change my mortgage from variable to fixed?
Switching your mortgage from a variable-rate to a fixed rate can be relatively simple, whereas switching from fixed to variable (before the end of the fixed term) can be much more of a challenge given you will likely face expensive break costs.
4. Why doesn't Australia have 30-year fixed rate mortgages?
There may be a few reasons why there aren't 30-year fixed-rate mortgages in Australia. One simple reason might be because there's a lack of demand for them. Most Aussies are happy to take out variable-rate mortgages, knowing that variable rates often have lower interest rates than fixed rates. A slightly more complicated reason is that Australia's debt market is not developed enough to allow lenders to easily on-sell bundles of 30-year fixed mortgages to investors, so lenders are generally unwilling to offer them because it means they are likely to be stuck with 30-year fixed loans on their balance sheet.
5. How do I get out of a fixed rate mortgage?
A fixed rate home loan is a legal contract guaranteeing your mortgage will be charged a fixed rate of interest for a specified amount of time. If you decide to break a fixed rate home loan contract, your existing lender must be compensated for any loss they incur. You will have to pay two fees: a break fee (which can be very expensive) and a discharge fee, which is usually a few hundred dollars.
Savings.com.au’s two cents
If you’re weighing up between variable or fixed home loans, have a think about what you want from your home loan. Knowing what you need from your home loan will help you decide which rate type will suit you.
Scott Pape, the author of the best-selling book The Barefoot Investor, had this to say about fixed-rate home loans in his book:
“The only reason you would fix your rate is if you’re really struggling and you want the security of fixed repayments, but for everyone else it’s too much of a gamble”.
Most people choose to fix their rates because they need financial certainty. For others, it’s about trying to beat the banks at their own game and secure the lowest possible rate.
Whatever your motivation is for wanting to fix your home loan rate, consider your long-term financial needs and goals, do your research, and make sure you understand the advantages and implications of fixing.
The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:
- The big four banks are: ANZ, CBA, NAB and Westpac
- The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2019. They are (in descending order): Credit Union Australia, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
- The larger non-bank lenders are those who (in 2019) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site.
In the interests of full disclosure, Savings.com.au and loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.
*The Comparison rate is based on a $150,000 loan over 25 years. Warning: this comparison rate is true only for this example and may not include all fees and charges. Different terms, fees or other loan amounts might result in a different comparison rate.
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