Why fixed rate home loans may be dangerous

author-avatar By on April 09, 2021
Why fixed rate home loans may be dangerous

Ultra low fixed rates have been all the rage lately, but some borrowers may not understand the risks they can carry.

When the Reserve Bank (RBA) last cut the cash rate in November many lenders didn't have the capacity to cut variable rates, and instead started offering rock-bottom fixed rates, some even below 2%

Lenders have been able to do this partly as a result of the RBA's Term Funding Facility (TFF), which provides funding at interest rates of either 0.10% or 0.25% over three years. 

This facility has also allowed many lenders to offer cashback offers to entice borrowers to refinance to a fixed rate loan with them.

The TFF expires in June, and although the central bank has said it won't raise the cash rate before the end of 2024, many economists and lenders are betting it will have to hike before then. 

All of this may seem irrelevant to borrowers who have fixed their home loan and assume they're safe from interest rate rises.

But when a fixed rate period ends, borrowers are switched onto lenders' standard variable rates (SVR), which are often much higher than the variable rates lenders advertise. 

This is called a revert rate, and Chief Financial Officer at non-bank lender Firstmac James Austin said this switch posed a serious risk to borrowers in a few years. 

"Rates will reset to the banks' SVR, currently around 4% ~4.5%. By the end of three years the cash rate is anticipated to have risen to around 0.50%, taking these SVR to 4.5% ~5.05%," Mr Austin told Savings.com.au.

"That is a huge jump from the current 1.99% fixed rates on offer. This may well challenge the serviceability of many borrowers." 

But Mr Austin, who forecast the RBA may hike the cash rate by the end of next year, said borrowers should reconsider fixing. 

"The short term sugar hit from cash upfront will translate to higher rates in the future," he said. 

Commonwealth Bank recently hiked two of its four year fixed-rate home loans, and some in the industry have started speculating the big four lender believes the RBA will hike rates sooner than expected. 

Buying a home or looking to refinance? The table below features home loans - fixed and variable- with some of the lowest interest rates on the market for owner-occupiers.

Base criteria of: a $400,000 loan amount, variable, fixed, principal and interest (P&I) home loans with an LVR (loan-to-value) ratio of at least 80%. However, the ‘Compare Home Loans’ table allows for calculations to made on variables as selected and input by the user. All products will list the LVR with the product and rate which are clearly published on the Product Provider’s web site. Monthly repayments, once the base criteria are altered by the user, will be based on the selected products’ advertised rates and determined by the loan amount, repayment type, loan term and LVR as input by the user/you.

"False sense of security"

AMP chief economist Dr Shane Oliver said many borrowers didn't realise their repayments could dramatically lift when the fixed term ended. 

"The main danger is in being lulled into a false sense of financial security on the back of the ultra-low fixed rate and not allowing for a possible lift in interest payments if there is a reversion to a much higher variable or even fixed rate when the initial fixed rate ends," Dr Oliver told Savings.com.au.

"The key is to make the most of the low rate to get the mortgage down faster than otherwise, e.g. by paying the same amount into your mortgage as if you are still on a higher variable rate." 

However, Dr Oliver said fixing a home loan was still a viable option for many borrowers, and urged people to consider a split-loan

"Fixed rates are generally well below variable rates and so the interest saving should be taken advantage of, particularly if the savings are used to pay down the mortgage principal faster," he said. 

"A sensible approach is to leave some variable though to provide some flexibility."

Dr Oliver added he believes the RBA will hike the cash rate in the second half of 2023, allowing the central bank to meet its employment and inflation objectives earlier than expected. 


Photo by Syed Hadi Naqvi on Unsplash

Disclaimers

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 2020. They are (in descending order): Great Southern Bank, 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 2020) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
  • If you click on a product link and you are referred to a Product or Service Provider’s web page, it is highly likely that a commercial relationship exists between that Product or Service Provider and Savings.com.au

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, Performance Drive 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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Alex joined Savings.com.au in 2019. He is passionate about providing Australians with the information and tools needed to make them financially stable for their futures.

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