We answer one of the most difficult home loan questions around: should fix your home loan?
Even if the majority of home loans in Australia are of the variable flavour, there are many reasons why fixed rate loans are beneficial to borrowers.
Variable rate loans have interest rates which fluctuate over the course of a loan term. Each month the Reserve Bank of Australia meets to determine what the new cash rate target will be. This can push mortgage rates up or down.
Fixed rate loans differ in that you take out an agreed fixed rate for a number of years, usually 1 - 5. During this time your rate stays the same regardless of what the RBA decides, and therefore your repayments also don’t fluctuate.
Locking in a rate for a number of years isn’t a decision to take lightly. There’s always the risk that you’ll be stuck with a rate much higher than those offered on variable rate loans if the RBA decides to cut the official cash rate after you fix. There’s also the flip side: you might enjoy a loan with a rate much lower than the variable rate loans available if the RBA cuts rates.
Comparison of fixed rate home loans
How do fix rate loans differ from variable rate loans?
As mentioned, fixed rate mortgages differ from variable rate loans in three main ways: rates, fees and features.
- Rates - A fixed rate won’t change over the course of the agreed term. This means if you lock in a rate for three years your repayments will not change. This is useful if you’re sticking to a tight budget, or if you’re an investor looking to guarantee your cash flow won’t decrease over the next few years.
- Fees - Fees can differ depending on your lender and the loan type, but one fee that is specific to fixed rate loans is the break cost. Break costs are charged when you exit a fixed length before the term is up. Because your bank itself borrows money from various funding sources when providing you with your loan, break costs are calculated using the rate your lender paid for your funds compared to the rate you locked in. They also take into account how long your fixed term still had until completion, and the loan size.
- Features - As is the case with fixed rate fees, the features they offer depends on the lender and the type of loan you obtain. The most common feature a fixed rate loan doesn’t have is the ability to make additional repayments. Most fixed rate loans will either not allow extra repayments, or limit this to a set amount each year - usually between $10,000 - $20,000. Many fixed rate home loans also don’t come with the option to use 100% offset accounts.
How do I know if it’s a good time to fix?
If you listen to advertisements from banks and other lenders, it’s always a good time to fix. Advertisements for fixed mortgages play on two fears - the fear of rates rising to a point where you can’t afford repayments anymore, or the fear that you’ll miss out on savings if you don’t lock in a great fixed rate before rates rise.
Here are a few ways of finding out if you should fix:
- Check our RBA page. Our monthly survey collates data from the top economists and commentators in the country. They’ll regularly drop hints about where they think interest rates will be in the medium to long term. You can use this to find out what they think will happen to the cash rate, and therefore whether you should fix in a good rate or wait for further rate cuts before fixing.
- Do you plan on making additional repayments towards your loan? As mentioned, fixed rate home loans generally don’t allow you to put extra repayments on your home loan, which can reduce your loan term and the interest payable. If you think you’ll want to put extra money towards your loan during the fixed term, it may be better to seek a variable rate home loan or choose a fixed rate home loan which allows additional repayments.
- Are you happy keeping your property for the length of the fixed term? A lot can happen in the space of a year, let alone five. Keep in mind that if you exit a fixed home loan, you can be liable for break costs which can cost thousands. If you’re thinking of selling your property in the short term, a fixed rate home loan might not be the best choice for you, as you might be required to pay these break costs.
How long should I fix for?
This is linked to the question above. The length of time you fix for should take into account your lifestyle choices, such as whether you intend to sell your property over the course of the next few years, and whether or not you intend to put more of your income towards making loan repayments.
Economic information should also have a bearing on how long you fix for. If many leading economists believe rates will rise within the year, there’s a good possibility that this could happen. In reality, forecasting rates is difficult and depends on a range of complex factors, meaning it’s never completely reliable.
You might also want to obtain the advice of an experienced accountant, mortgage broker or financial planner, as they can help you work this out in conjunction with examining interest rate trends and other economic data.
How can I compare fixed rate home loans?
If you’ve decided fixed rate home loans are right for you, a comparison should take into account the following:
|Rates||You’ll want to compare both the advertised rate, and the comparison rate, which will take into account some of the fees you’ll have to pay with these loans into the rate. Rates will have a direct influence on the size of your repayments.|
|Fees||Home loans can come with a range of fees including application fees, legal fees, settlement fees, annual or monthly fees and valuation fees. Compare these when viewing different home loans.|
|Features||Fixed rate home loans generally have less features than variable home loans. It’s still a good idea to find out if you want a 100% offset account or the ability to make additional repayments, as well as a redraw facility, before you start comparing home loans.|
The split rate solution
If you’re new to fixed home loans, one way to try them out first is with a split rate. This feature basically allows you to split your home loan into two or more portions and then choose a combination of fixed and variable rates for these portions.
This could mean you have a small portion of your loan using a fixed rate, and then have the remainder calculated using a variable rate.
Keep in mind that some lenders may have minimum amounts you can split your loan into, and might also limit the number of times you can split your home loan. They might also charge fees for splitting your home loan.
As mentioned above, it’s a good idea to speak to a broker, accountant or financial planner before taking out a split rate home loan.
Fixed home loans can offer a range of benefits for all types of borrowers. Just be sure to seek adequate advice before signing on the dotted line.