As a mortgage broker one of the most common questions I receive from clients is whether they should fix the interest rate on their Home Loan. Since the commencement of the COVID pandemic there has been a surge in clients locking in at least some of their Home Loan into a fixed rate to take advantage of the very low rates on offer in this market, in some cases well under 2%.
Now, with commentary from the Reserve Bank indicating that they may be looking to increase the cash rate a lot earlier than expected due to inflation, most lenders have started to lift their advertised fixed rates, particularly in the popular 2 and 3 year fixed rate products. At the same time some of their variable rate products have started to come down, with Banks trying to encourage more customers into these products, anticipating that there may be several rate rises from the Reserve Bank in the future.
Given the current interest rate uncertainty is now the best time to fix the rate on your Home Loan? There are advantages and disadvantages to locking in your interest rate which would determine if fixing your rate is the best option for you.
When you fix a rate on your Home Loan you are guaranteed that the rate will not change for the period you have fixed for. This means your repayments will also remain unchanged which is helpful for household budgets.
- Potential Money Saver
If you are able to fix your rate at the right time you will save money on interest, potentially thousands of dollars. For example, if you were to fix a rate today you could lock in for as low as 2.09% for two years with some lenders. These same lenders have variable rates at 2.69%, and if those variable rates do not reduce below 2.09% over that two year period the benefits of fixing at the lower rate would be substantial.
- Some Flexibility
Most lenders will allow borrowers to make additional repayments when they have a fixed rate loan without incurring a penalty. It is most common for any extra repayments to be capped at a maximum $10,000 per year.
Some lenders also offer the ability to have an offset account linked to the fixed rate loan to help reduce interest costs further, although these are generally only partial offsets usually 40%. For example if you had a $1,000 balance in an offset account only $400 of that balance would be offsetting your loan.
- Penalties may be payable for early repayment
If you become dissatisfied with your lender, decide to sell your home or you simply want to take advantage of better deals elsewhere, when you are locked in to a fixed rate you could be charged a substantial interest penalty to break the contract. A complex formula is used to determine what the loss to the lender would be if the fixed rate contract is broken which is outlined in any Home Loan Contract. This penalty could offset any benefit you received by locking in originally.
- Most flexible features are unavailable
Flexible features that are standard on most variable rate loans are either not available or offered with reduced benefits on a fixed rate loan. Offset is typically not available, or only offered as partial offset which reduces the effect it has on interest saving, and redraw is also not available on fixed rate loans.
- Potential to lose on the interest rate bet
Fixing a rate is effectively betting that the fixed rate will be lower than the variable rate for the time you choose to lock in for. In a volatile interest rate environment, where variable interest rates are dropping, if you have a fixed loan your rate will not reduce. The inflexibility of the fixed rate which is great in stable environments can be a curse at other times.
- Potential for higher repayments once the fixed rate expires
A large number of borrowers have fixed their rates at historically low rates for the next few years. Once these rates expire the new interest rate may have increased significantly during this period, so their loan repayments could be much higher than what they have been used to paying. Borrowers could be in for a rude shock in the next 2-3 years.
If you can’t decide which option is the best one for you it is possible to hedge your bets. Lenders also offer a split loan option which means you can have a portion of your loan at a fixed rate and the balance on a variable rate. By splitting your loan you retain the flexible repayment features of a variable rate loan, as well as having some of your loan locked away securely on a fixed rate for a few years.
It is always a great idea to speak with a mortgage broker who can guide you through the process, advise you on which loan structure would suit your needs best and recommend the most suitable lender to meet your requirements.
At SHL Finance we are available to speak with you at any time. We are already proactively helping our clients negotiate a better rate with their current lender, reviewing their existing loans and discussing ways to potentially save clients thousands of dollars. We would love the opportunity to help you too. Please call Reece Droscher on 0478021757 to discuss your options.