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Mortgage Advice: Is It Time To Fix Your Interest Rates?

In Buying a House, Mortgages by Phil McGilvrayLeave a Comment

As a financial advisor, clients are always thinking of ways to save money and pay off debt. One of the most common questions I get asked are, “Should we consider fixing the interest rates on our home loan?”

Interest Rate Trends

For many years now our interest rates have drifted lower, on the back of a deteriorating economic environment. While many economists are still predicting lower rates over the coming 12 months, there is no denying that a 2% RBA rate and 4.5% – 5% variable home loan rate is exceptionally good!

Just ask anyone over the age of 50, no doubt you’ve heard it – “Back in my day I remember when the rates on our mortgage were 18%”.

Believe it or not this is true, although home loans were significantly smaller back then thanks to more sensible lending policies by the banks. While 18% home loan rates are significantly unlikely, it would be naïve of us to think that rates will stay this low forever.

The 50-year home loan average is closer to 8.6% and if you take out those years of high inflation and high interest rate during the 1980’s, 7.5% seems to be a reasonable long-term average.

The Future of Interest Rates

Given the state of our economy it is very hard to see the reserve bank increasing rates any time soon. However, it’s not so much the reserve bank we need to watch but rather the banks we have borrowed from.

Late last month all four of the major banks increased their variable home loan rates by 0.25% citing the increased cost of new regulatory requirements as the reason for the increase.

It is also worth noting that the major banks will start to increase their fixed rates well ahead of the variable home loan rates and well ahead of the reserve bank. This means if you wait until there is talk of rising interest rates in the news, you will probably have missed the best opportunity to use this strategy in your budget.

Fixing Your Interest Rates

While I don’t think there is rush to fix rates yet, the mortgage advice that I suggest to my clients is to hedge your bets. You do not have to be all fixed or all variable – generally a combination of each is a good compromise.

If you like the certainty that fixed rates provide, it is worth fixing a portion of your home loan rate for 2, 3 or even 5 years within the next 6-12 months. I actually prefer to use the some fixed and some variable as a strategy for breaking down the home loan into chunks that can be easily paid off.

For example, if you had a $300,000 home loan debt and thought you could aggressively pay down $30,000 each year you might:

  • Fix $100,000 for 5 years
  • Fix $100,000 for 3 years
  • Leave $100,000 variable

Then, you would set yourself the goal of paying off the $100,000 variable before the 3 year fixed portion of your loan matured.

Breaking up your mortgage into chunks can make paying off debt on your home loan seem far more achievable. Instead of looking at the full loan amount, focus instead on the variable component and throw everything you have at knocking it over first.

What to Know Before Fixing a Home Loan

Before fixing a home loan there are a few things that you really need to take into consideration:

  • Typically, you can only pay an extra $5,000 – $10,000 of the loan principal each year. Now you might be thinking, “There is no way I could ever pay more off the mortgage anyway”. But you need to understand that if great Aunt Bertha passed away and left you some money, you are unlikely to be able to pay down the fixed portion of your loan with it.
  • You typically cannot set up an offset account against a fixed rate loan. Offset accounts are a big part of our recommended bank account structure. As long as you still have a portion of your home loan as variable this probably doesn’t matter too much.
  • The cost of breaking a fixed rate loan can be very high. Depending on how high the rates are and how much longer you have left on the loan, ‘break costs’ can add up to tens of thousands. So, if you think you are likely to move houses or refinance your home loan for any reason, you may want to think carefully about how you use a fixed rate loan.

While I don’t believe there is a need to rush into fixing rates just yet, if you have a large home loan and prefer the certainty that fixed rates provide, you might want to consider fixing a portion of your home loan. Fixing part of your home loan while leaving a chunk you can aggressively pay down is an excellent strategy I use with many of my clients. The one caveat is make sure you understand the restrictive terms and conditions that come with a fixed rate home loan.

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