Many people want to know whether they should fix (or set) the rate on their home loan, rather than riding the wave of variable interest rate fluctuations. Interest rates fluctuate due to changes in the performance of the economy. The Reserve Bank of Australia meets every month to decide whether the Target Cash Rate or rate at which Lenders access money at Wholesale prices should rise or fall. Lenders then pass some or all of this change onto their customers through variable interest rates.
Fixed rate loans typically work like a long term contract. You fix in a rate for a certain time period, like 3 years, with a fixed monthly payment. There are usually substantial break penalties for ending the fixed loan term.
There are some benefits of a fixed rate loan:
Certainty of repayments
With Fixed Interest loans the repayment amount will not change for the period that it is fixed, allowing the customer to plan and budget with certainty.
Saving money when rates rise
When Interest rates rise (and history will say that eventually they do) then you will save money. With current rates at historical lows, many people are considering fixing their rates.
Case Study of Fixed Loan – Warren
Warren has been saving hard for a long time and has just bought the house of his dreams, using his savings and a 30 year loan for $600,000. He has also recently commenced work on a new IT project which will see his income stay the same for the next few years, so he has decided to enter into a fixed Interest rate home loan for the next 3 years.
The current Variable Interest Rate is 4.9% and Warren has been able to negotiate via his Broker a fixed interest rate over 3 years at 5.00%.
His repayments will be $3,221 per month (whereas on a Variable Interest Rate the repayment would be $3,184 per month)
6 months later the economy has been booming and Interest Rates have risen so the variable rate is now 5.4%. Warren is still paying $3.221 every month, whilst he would have been paying $3,369 if he was on variable rates, so in this case although he was paying more at the outset now is $148 better off every month.
So in this situation, Warren has done well out of fixing interest rates. On the flip side though, there are of course, potential pitfalls.
You won’t benefit from rate decreases
If interest rates continue to fall, you won’t benefit in the same way as if you had stayed variable. The arrangement is like a long term contract, which you can’t get out of easily or without incurring break costs. There are people who have fixed loans right now that are effectively ‘missing out’ on the latest round of rate cuts.
Less ability to move around
Banks like offering fixed term rate contracts, because they lock customers in. For astute borrowers who may want to shop around at a later date for a better deal, or whose circumstances change, fixing your rate will not provide the flexibility to move without incurring costs.
If you really want to hedge your bets, you can have part of your loan fixed and part of your loan variable. Then you get the best of both worlds, sort of. If you’re unsure have a chat to your Broker.