June 6, 2018

Should You Choose a Fixed Rate Loan?

Home Loan Fixed Rates – are they a gamble? This is a thought that has been occupying What If We Finance more and more and as recent research by Canstar has found that typically its a 50/50 proposition. More specifically, will you come out ahead financially when fixing your home loan?

As an example, the research shows that borrowers who fixed for 3 years during the GFC in 2008 were on average $22,000 worse off. The cash rate had peaked at 7.25% before it fell to 2.5% and as Canstar’s research shows when fixing a home loan, it is extremely difficult to predict what may happen during the fixed rate period.

Canstar’s research assumes a $300,000 interest-only home loan and compared the losses and gains of fixing relative to a variable rate. In addition, borrowers who fixed their home loan in November 2005 would have been $25,000 better off, conversely borrowers who fixed in March 2005 would have been worse off.

Canstar’s research validates mortgage broker What If We Finance’s opinion, many things can change during a fixed rate period and the recent economic volatility illustrates this. You only have to look at the press and opinions on whether interest rates will go up or down vary week by week or by economic news release.

Let’s further discuss the pros and cons of a fixed rate loan.

What is a Fixed Rate Loan?

Before we further delve into the probability of risk of fixed rates, let’s first define what it is. In a nutshell, it’s a mortgage with an interest rate that stays constant for a set period of time — typically between two to five years. As the interest rate is fixed, your monthly mortgage repayment stays the same for the term’s duration, providing you with cash-flow certainty. This is why fixed rate home loans are popular for investors – they can plan ahead and budget for the future.

A fixed rate loan is a good option because any rises in interest rate will not affect the amount of interest you pay. However, if interest rates drop, you also end up paying more interest compared to someone with a variable rate loan.

What Is a Variable Rate Loan?

A variable rate loan is the opposite of a fixed rate loan. The interest rate – and consequently your monthly loan repayment too – can rise or fall at any point during the mortgage term due to changes in the market.

Variable rates have appealing features such as the ability to make extra repayments to save you interest while paying off your loan sooner. However, they are generally riskier than fixed interest rate loans. You have to take into account potential rate rises, making it more difficult to budget your interest payments.

The Risks That Come with a Fixed Rate Loan

We have established the idea that fixed rate home loans can be beneficial for mortgage holders due to the stability they provide. However, there are still varying risks for borrowers in fixed rate mortgage loans. Here are some of them:

Paying break fees

If you need to switch out of a fixed rate home loan, it’s likely you’ll need to pay a significant break fee. Depending on the size of your loan, loan term and interest rate movements, these break fees can reach thousands of dollars easily.

So, if you feel like you may want to change loans in the future or consider moving homes, having a fixed rate loan can be risky. Ask your mortgage broker for further advice on your situation.

When interest rates fall, you can end up paying more

The big risk with a fixed rate is that interest rates can continually drop, which leaves you paying more in interest than you would otherwise. As interest rates are mostly impossible to predict, any decision to fix your rate should be made after you’ve assessed your budget and affordability.

If you’re tempted by some relatively low fixed home mortgage rates, bear in mind that they be low for a reason. For instance, when lenders think there’s a strong chance for interest rates to decline in the near future, many of them try to tempt borrowers into taking out a fixed rate mortgage. This means there will be fewer customers for them to pass on future rate cuts to. It’s like you’re making a bet with your lender over whether the market interest rates will go down or up. If rates rise, you avoid a rate hike. If they fall, you miss out on rate cuts.

Fixed rate loans often have extra repayment limits

Most fixed rate loans will limit your ability to make extra repayments. Loans will typically allow for a specific number of extra repayments each year or over the loan’s term. Once you exceed the limit, additional repayments may attract fees.

Should You Choose a Fixed or Variable Rate Home Loan?

There is no right or wrong answer to this question. It ultimately depends on your overall attitude to risk and personal circumstances. If you are inexperienced, worried about the stability of your financial situation, or simply the type of person who wants to be assured of how much they’ll pay each month, a fixed rate loan is the better option for you.

With that said, a fixed rate loan can still be a gamble. Interest rates might decline, which leaves you paying more interest compared to if you opted for a variable rate loan. Of course, it’s hard to predict the certainty of future home loan interest rates. But if you’re new to the market and don’t feel comfortable taking risks, then fixing your loan could be the best strategy.

Just about all lenders in Australia offer both fixed and variable rate home loans. The most common fixed rate loans in Australia are one-year to five-year fixed rate terms. Few lenders offer 10-year and 15-year fixed terms.

Make Smart Decisions with What If We Finance

Fixing a home loan provides certainty of repayments and should not be solely done to save money. Predicting interest rates is risky and things change quickly and remember it is very hard to beat the bank!

Contact your mortgage broker from What If We Finance if you would like to find out more about fixed rates. We have the experience and the expertise to provide you with valuable advice concerning fixed rate mortgages and figure out the best loan product for your unique situation.

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