It’s probably one of the most asked questions when it comes to mortgages. On the one hand, you have the certainty of repayments over the fixed period, while on the other you might reap the benefits of lower interest rates in the short term by staying on a variable rate.
If you’re an avid follower of Scott Pape, and the “Barefoot Investor”, then you’ll know that he is all about the variable rate option. Citing that the banks LOVE to lock clients into fixed rates, as quite simply, it makes it harder for you to leave and take your business elsewhere.
However; to understand the decision before you, let’s have a re-cap of exactly what each option involves:
You go to your bank or broker as they’re offering you a rate of 3.99% fixed for 3 years and that sounds like a jolly good deal to you.
What it means is that for the first 3 years of the loan your interest rate will be 3.99%, no matter what happens in the wider economy.
So, if the cash rate (the rate set by the RBA – Reserve Bank Australia) goes up, and therefore the banks cost of funds increase, they may choose to raise their variable home loan rates. This won’t affect you as you still get the 3.99% rate that you were fixed on! At the end of your 3 years you will be given the option to re-fix at the new market rates, otherwise your loan will just go to the variable rate.
Sounds good right? But what if the rates go down?
If the variable rates go down during your fixed period then unfortunately you don’t get the benefit of the reduction, as you agreed to pay 3.99% for the 3 years. This means you may end up paying significantly more during your fixed period, due to forces outside your control. We have clients who fixed loans for 5 years at 6.9%, because at the time those rates seemed like a great deal, 5 years later they’re coming off their fixed rate and going back on to a variable rate at nearly 3% less than what they’ve been paying. Ahhh hindsight, it’s a wonderful thing!!
Main Pro’s – Certainty of repayments! Having a fixed interest rate means you know exactly what your repayments are going to be over the life of the fixed period, as the rate does not change.
Con’s – Life happens! – Who knows what the future holds?Chances are things might change in your life, the house you thought was going to be your forever home might turn out to be a stepping stone to next place. Once you fix your home loan, the bank locks that rate in on their end and enter into a contract with a wholesale money market to fund your loan – at a set interest rate. So if all of a sudden you want out early, they may incur costs themselves, and guess what? … they’ll pass them on to you!
You’ve seen a great variable rate on offer at 3.69%, but you’re not sure what is meant by variable? Well, quite simply it means that the bank can opt to change the rate at any time it likes. Now this can really freak some people out… “What if they just decide to put my rate up to 10% next week?” Well… this doesn’t really tend to happen – why? Because you’d just take your business elsewhere, as would everybody else!
Variable rate mortgages are a far more flexible proposition as there are no hefty break costs associated. In fact,in 2011 the government banned exit fees on all variable rate mortgages. That’s not to say it will be totally free to leave, as the bank can still charge you for any actual cost incurred by you leaving i.e. the costs associated with removing the mortgage that has been registered on the title of your property, the average discharge fee in Australia is around $300.
Variable loans also tend to have greater flexibility in terms of loan features, such as offset accounts, redraw facilities, extra repayments, repayment holidays and progress draws for construction loans. Be sure to look out for future blog posts covering the benefits of some of these features!
Main Pro’s: Greater flexibility and potential interest rate advantages if the cash rate reduces during your term. Rates typically lower at the time of application than their fixed counterparts.
Con’s: Rates subject to change.
The simple truth is different people like different things, that’s why the two options exist! By far the most popular option in Australia is the variable rate loan, in fact less than 20% of Australian Mortgages are on a fixed rate. Does that mean that you should blindly follow everyone else? Of course not, you should sit down with your broker or financial adviser and consider all of your options and do what you believe is best for you!
The Golden Rule: if you choose to fix your interest rate on your mortgage, remember that you did it for a reason! At the time it worked within your budget and you decided it was the right thing for you. Don’t let yourself get buyers remorse!!
Take a look at our Loan Comparison Rate Calculator here
At Lend Me, we love what we do and we love assisting you with your financial needs. Our experienced brokers are here to turn the market jargon into plain English. Send us and email at firstname.lastname@example.org or pick up the phone and gives us a call on (08) 6234 6400. We would love to hear from you!