To fix (your home loan) or not to fix? That is the question!

With interest rates at record low levels, the big banks are now offering borrowers the most enticing deals ever. Subject to approval, borrowers are now able to fix their mortgage rate below 2% for 4 years with some banks. The question is – is this a once-in-a-lifetime chance you should grab with both hands or is there a catch and it’s too good to be true?

Some experts are saying we may never see fixed rates this low again, while others urge borrowers to consider the limitations of fixed rate loans before diving in. This article considers the commonly asked questions and pros and cons of fixing your home loan.

Firstly, let’s compare the rates on offer. According to Canstar, the current average two-year fixed rate is 2.3%, while the average variable rate is 3.33%.

Is there a trade off when fixing your loan at such a low rate?

Yes. There is reduced flexibility to make extra repayments because many fixed rate loans don’t have an offset and others don’t have a redraw facility. This may not be an issue for you, but it could be if you wish to make extra repayments, such as if you were to receive a windfall (such as an inheritance) that you want to pay onto your mortgage to reduce the amount of interest payable.

What if rates drop further?

It is certainly not beyond the realms of possibility for the RBA to slash the cash rate further. The key is to be aware that when you fix your loan there is a chance that the variable rate could drop further and accept that this is a calculated risk you are prepared to take.

What if the economy worsens rather than recovers?

If the economy doesn’t recover and actually worsens, we would likely move to negative rates. If you had a fixed rate loan and had to sell or refinance in this situation, you would incur an exit fee. Why? Because banks borrow funds for fixed rate loans from financial markets. If a borrower repays a fixed rate loan early, the lender’s original loan term remains the same. Banks will therefore charge borrowers who repay a loan early a ‘break’ or ‘economic’ cost, even when selling. The more interest rates fall, the higher break costs will be. That is the risk you take.

Is there a way to combat the trade-offs?

One way to combat the trade-offs is to fix a portion of your loan and leave the rest variable. This is commonly referred to as a ‘split home loan’. This option allows you to plan for changes to your circumstances that enable you to make additional repayments. 

The good news for borrowers who decide to fix their interest rate on the loan (or a portion of it) is that interest rates are not expected to drop much further. The risk of fixing would have been much greater when the rates were higher.

Who should not be fixing their loan?

Anyone who is uncertain about their future employment or industry and/or their partner’s employment or industry should not fix their loan. Similarly, if there are any potential health issues in your family, you should think twice before fixing your rate.

The bottom line is, if you take on something that is fixed, you should do so only if your situation is as fixed/stable as possible, at least for the foreseeable future.

Post by ShelMarkblog 16 Jan 2021 0