In the April meeting, the Reserve Bank of Australia (RBA) kept the cash rate on hold for the 20th consecutive month, at the record low of 1.5%. The cash rate was reduced from 1.75% to 1.5% in August 2016, and there has not been an increase in the cash rate since November 2010.
Most of the ‘experts’ predict that rates won’t rise until next year due to slow wages growth, and general economic conditions. Although some of the banks have increased their rates outside of the RBA cycles, many borrowers have taken advantage of the competitive home loan market to access lower rates and save on their mortgage repayments.
Given that we are currently in a record low-interest rate environment, and logic would dictate that rates are most likely to go up, does it make sense to fix your home loan? Well, as with most financial decisions, there are pros and cons to consider with fixed rate vs variable rate mortgages.
Some of the key features of fixed rate and variable rate loans are shown below:
Fixed rate loans
- Fixed rate loans can provide peace of mind and avoid the risk of rising interest rates. If interest rates increase above your fixed rate, you will enjoy the savings as your repayments are locked in.
- At the end of the fixed rate period, the loan may revert to a much higher variable interest rate.
- If interest rates fall, you will miss out on any savings, as your fixed rate is locked in until the end of the term selected.
- Fixed rate loans are typically higher than variable rate loans, and charge break costs if you repay the loan early, wish to switch providers, or change to a variable rate before the expiry of the fixed rate term. The break costs are to compensate the lender for the loss of projected earnings on the loan and can be several thousands of dollars.
- Fixed rate loans may limit the amount of additional payments you can make above the minimum repayment amount. A penalty may be charged for exceeding the maximum repayments allowed each year, or in the fixed rate term.
- Fixed rate loans offer less flexibility, and do not provide full offset accounts. Some providers offer partial offset accounts, and depending on the provider, you may not have the ability to redraw.
Variable rate loans
- Variable rate loans typically allow greater flexibility. You may be able to make unlimited repayments without penalty, and redraw the funds as required.
- Variable rate loans can offer more comprehensive features such as a full offset account(s). An offset account will allow you to reduce interest costs by linking a savings/transaction account. The balance held in the account will offset your home-loan and allow you to have access to that money as required.
- If interest rates fall, your lender may reduce the rate so you can take advantage of reduced repayments.
- If interest rates rise, your repayments will increase to the rate set by your lender.
- Variable rate loans usually allow you repay the loan before the end of the loan contract without break costs or penalties. A standard discharge fee would apply.
- If interest rates start to rise unexpectedly, you can convert the loan to a fixed rate. An additional application fee would apply.
Unfortunately, no one has a crystal ball and it can be difficult to predict when rates may rise. Another option may be to split your loan.
A split loan facility allows you fix part of your loan and leave part of the loan on a variable rate. By splitting your loan, you have protection against increasing interest rates on the fixed portion, and you will have the flexibility of making extra repayments, and the features available on the variable portion.
There are many issues to consider before making any changes to your home loan. Before you decide on what option would suit your needs, take the time to understand the pros and cons of fixing your home loan. One of our friendly mortgage brokers might be able to save you thousands over the life of your home loan/s.
Please note that the above is given as general advice. It has not taken your personal circumstances into account. If you would like more tailored advice, or to learn more, please contact one of our lending specialists to determine the costs and benefits, and to discuss your options.