By Jason Dunn
Home owners and investors have been thoroughly spoiled lately by the highly competitive home loan market. Those who have taken advantage of the rates on offer from lenders are clearly enjoying the savings they’re making on their mortgage repayments.
Home loan fixed rates currently sit well below the standard variable rates (SVR) so, at the moment, it’s possible to cut your interest costs by fixing. But there are pros and cons associated with fixed rate mortgages, so before you make a change, you should consider all possibilities before making a final decision.
Fixed-rate loans, as a proportion of all new home loans, sat at 13% in July 2016 up from 10% a year earlier, according to data from the Australian Bureau of Statistics. As it stands, most people still take out variable home loans, but fixing has become increasingly popular on the back of lower interest rates.
According to data from the Reserve Bank of Australia, as at July 31, 2016, the average three-year fixed rate was 4.25%, down from 4.65% a year earlier. This sits well below the average standard variable rate of 5.40% for owner-occupier bank loans and below the average discounted variable home loan rate of 4.60%.
However, although a fixed rate home loan can offer good protection against rising interest rates, it’s important to consider all aspects of fixed loans which are generally far less flexible than their variable siblings.
Clearly, the best time to fix a rate is when variable rates don’t look like they will fall any further in the short to medium term. It’s easy to see why - you only achieve an interest-rate saving with a fixed loan if variable interest rates rise during the term of the fixed loan.
But predicting interest rates is nearly impossible, so it is always a gamble. One inherent risk is that if interest rates fall, you might miss out on a cut in official interest rates and you’re stuck with the rate you locked in at for the duration of your fixed loan. This might actually end up costing you far more over the long-term.
However, if global economic growth improves, taking with it Australian economic growth, there’s a big chance that interest rates will rise. With a fixed rate, your interest rate costs and repayments won’t rise during the duration of the fixed loan term even if variable rates rise, so this can provide additional peace of mind.
So, all things considered, fixed loans are like a form of insurance that your interest payments won’t go up or down during the fixed term – but you may pay a premium for that insurance and peace-of-mind. Fixed rates can incur “Lock-in-Costs” which range from $500 - $750 per application on average.
There’s more you should consider before fixing the loan too. Before calling your broker or financial lender, think about these aspects too:
Limit on repayments
Most home lenders strictly limit extra repayments you can make on fixed loans. Some lenders don’t allow any extra repayments at all, while others will allow extra repayments up to a certain limit, often $10,000 or $15,000 a year. You can rarely pay more than $25,000 extra on a fixed loan, so asking your lender what limits they put on extra repayments is worthwhile, because if you pay beyond that level, you’ll be hit with penalty fees.
If you do repay a fixed loan off early, that is, before the end of the fixed term, you’ll have to pay break costs, which covers the lender’s economic loss – essentially because the lender won’t make their forecasted margin on the loan.
Break fees can amount to thousands of dollars; generally speaking, the more variable rates have dropped during the life of the loan, the higher the break costs will be as the lender will claim back what they stand to lose by you breaking the fixed term contract. So bear this potential cost in mind before fixing.
Check offset option
On top of break costs, you also need to be aware that in general, fixed loans generally don’t have offset facilities, which are common on variable loans.
Offset accounts allow you to cut interest costs substantially by allowing the balance in your savings account to offset your home-loan balance, thereby cutting interest charges, while having easy access to that money. However, there are exceptions to this and some lenders do offer partial interest-offset accounts on fixed loans. So check what your lender can offer you.
A split mortgage lets you fix a portion of your loan, and leave the remainder on a variable rate, so you can get some protection against interest rate rises but still have flexibility in terms of making extra repayments on the variable portion.
A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still retain some of the additional features variable loans offer, such as the ability to repay the loan early or make as many extra repayments as you like without penalties. That way, you can enjoy some protection against interest rate rises through your fixed loan but keep things flexible with the variable portion.
There’s a myriad of lenders in the market with a broad range of products available, so choosing a home loan can actually be more complex than it used to be. Lenders are becoming increasingly competitive and often they’ll be happy to discuss options with you, so you should get all the facts up-front to avoid surprises later.
Using the services of a home loan broker might also be a good consideration. They’ll scour the market for you to obtain a competitive loan and one that suits your circumstances. They can also be very knowledgeable and help support you through your application – often negotiating with the lender on your behalf. One benefit of using a broker is that it’s their business to remain up-to-date with the ever changing and increasingly complex and competitive home loan market. Another benefit of using a broker is the costs are generally covered by the bank you decide to go with. The broker needs to disclose the fees they are paid, which can also be a percentage of the loan amount. This keeps the service costs transparent.
Whatever way you choose to go, make sure you take the time to understand the benefits and drawbacks of fixing your home loan. If you’re unsure of which way you should go, talk to your lender or engage the services of a broker so they can guide you through the options you should consider.
General Advice Disclaimer: The information contained in this article is general in nature only and does not constitute personal financial advice. It has been prepared without taking into account your personal objectives, financial situation and needs. Before acting on any information contained in this document you should consider the appropriateness of the information having regard to your objectives, financial situation and needs.
About Jason Dunn
Jason is the GM Strategy & Distribution for Anne Street Partners Financial Services. He joined Anne Street Partners in February 2015. He comes with nearly 30 years of finance industry experience and 20 years of senior executive and leadership experience. Prior to joining Anne Street Partners, Jason was Head of St. George, Bank of Melbourne and Bank SA Financial Planning. During his five-year career at Westpac Banking Group, he successfully implemented and delivered many programs as National Westpac Financial Planning Client Value Program Director and State Head of Westpac Business Financial Planning.
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