WITH variable rates recently at 50-year lows and now starting to move upwards (beginning with a 0.25 per cent increase last week), the question many people are now asking is “should I fix my interest rate?”
As three-year fixed rates are already at an average of around 7 per cent and the discounted variable rates are around 5.3 per cent there is currently a valid argument that it’s now too late to fix. However this argument assumes you are using fixed rates to try and out-guess the market to get the cheapest rates, as opposed to a risk-management strategy.
The argument is that banks, which employ teams of economists and are supposed to know more than the average person, have already factored in what will happen with rates in the future. Meaning, that fixed rates already reflect the likely increase you will pay in the next few years.
What is often overlooked is the affordability of your loan should rates start to go much higher than anticipated. So for example, if your loan is $450,000 over a 30-year term and the rates went from 5.3 per cent to, say, 9 per cent (as they were only 12 months ago), the difference in principal and interest repayments would go from $2498 per month to a whopping $3620 per month.
It’s quite clear that when considering whether to fix, hedging for the cheapest rate must not be the sole consideration. You must factor in the maximum monthly repayment threshold that you can afford.
Of course, banks carry out affordability checks at the time of your loan application, however they generally use a buffer of around 1.5 per cent over the current variable rate. Because variable rates are currently so low, it is especially important to be aware of how high a rate you could tolerate before you would need to fix.
Rate calculators are freely available on sites such as www.mfaa.com.au. If you can afford a very high rate if rates went crazy, then you can afford the strategy of out-guessing the market described above, and for those who can afford the risk, it is fine to do. However if you can’t then you need to watch rates very carefully. A free interest rate comparison service is available at www.infochoice.com.au.
A common risk strategy is to “split” your loan, part-fixed and part-variable. Ask your broker to discuss these concepts for you. Either way it’s good practice to understand the risks you are taking, especially if you are a recent first home owner and not yet used to the impact of higher rates.
Read more from Virginia at www.modelmortgages.com.au
Your say: What do you think, should you fix your loan? Do you have any tips? Email us on [email protected]
