To fix or not to fix (your loan)
If you’re planning a renovation, just finished one, or you’re right in the thick of one, you may be well be re-evaluating your mortgage options. And if you are, you are also probably asking yourself the question – ‘Should I fix my loan rate?’.
There are always questions around fixed and variable rates, because people really want to know what they should do!
Some people take the crystal ball perspective – they try and predict what’s going to happen in the future, but to be honest, it’s a bit like being at the casino table and trying to figure out whether the ball is going to drop on a red or black number.
Banks employ rooms full of economists who try to figure this out every day and they still get it wrong!
The most accurate (and there’s still plenty of room for error) approach is probably the rear vision mirror view, which is to look backwards at what has happened with rates historically.
At the moment, interest rates are at an almost-60-year interest rate low, which is great for buyers right now. But if you speak to people who were buying houses in the 80s, they’ll be able to talk to you about the pain of borrowing on rates of 18%.
I’m 35 and in my ten-year borrowing life I’ve seen a big fluctuation with rates. One of my first loans sat in the 8 or 9% range and now we are seeing them halve to sit in the 4% range.
With all of that in mind, what looking in the rear vision mirror tells us is that right now interest rates are incredibly low and if it suits you, it is probably a great time to lock in a fixed low rate.
The third approach to take is to have a good look at your plans for the next few years and see what is on the radar that may dictate or limit the choices you make about whether or not to fix your rates.
Statistics show that every three years people adjust their home loan. And that’s usually because they are doing something in their life that requires them to make changes to their loan – they are renovating, getting married, divorced, having a baby, moving house etc.
For some people, the certainty of knowing what they will be paying out for their loan every month and that their rates won’t change over the term of their loan suits them perfectly.
But for others – especially when you bear in mind the three-year average loan adjustment – locking into a loan may not be the way to go.
You might be planning on flipping the house and buying again, you may want to renovate, you may be planning on having another baby. For whatever reason, locking into a fixed loan might not suit your life at the moment.
If you do settle on a fixed rate and then decide to change things, the bank will charge you for breaking the contract of your loan. This is called a fixed-rate break cost and it is set at a rate that covers what the bank will lose out on by you breaking the contract.
Something else to keep in mind when thinking about a fixed rate is while you do have the certainty of knowing what you’ll be paying on your mortgage for the term of your loan, a fixed rate means that you will not have the flexibility of a variable loan.
And that means you cannot pay extra off the loan. You can only make the scheduled payments over the life of the loan (although some do give you a capped additional amount, usually around $10,000).
So if you get a bonus at work, or you come in to an inheritance etc, you will be penalised with a fixed-rate break cost of you pay a lump sum into your loan.
But the good news is, you can have your cake and eat it too!
You can do this by fixing a proportion of your loan and leaving the balance on a variable rate. That way, whichever way rates move, one half of your loan is always winning.
If you are going to do this, have a really good look at what you have planned in the next few years to ascertain the best proportion of fixed to variable.
The final thing to consider once you have decided to fix all of your loan – or just a proportion – is how long you want to fix it for.
This is the million-dollar question.
Different terms will have different costs – sometimes the longer the term, the cheaper the rate, while at other times, the shorter the term, the cheaper the rate.
Your plans will be a good guide to the length of your term as well.
If you plan on flipping your property and buying again, you don’t want to be locked in to a loan and incur a break cost when you sell.
On the other hand, if you plan on renovating and holding on to the property as an investment or as an owner-occupier for a few years, now is probably a great time to lock down a loan at historic low rates, keep your repayments low and maybe even use some of the extra cash you are saving to buy yourself a second property.