To fix or not to fix?
Australia is experiencing unprecedented low rates, but does this mean you should fix your mortgage? Consumer finance expert Lisa Montgomery explains.
To fix or not to fix? That is the question – especially in a historically low-rate market.
The recent meeting of the Reserve Bank (RBA) yielded no material change to the cash rate for the 33rd month in a row, despite rates currently sitting at the lowest point we've seen for years.
Yet, in this unprecedented low-rate environment, financial institutions are starting to set the pace for the standard variable rate separately to any RBA movements. This creates an interesting situation for borrowers.
Five years ago, even a quarter of a percent change to the cash rate would have a significant material effect on interest rates. Banks and lenders would amend their rates in accordance with the RBA and it was a defined process. However, in recent times, the movement of the official cash rate has been somewhat diluted. Regardless of the cash rate holding, banks and lenders have both increased and decreased their interest rates out of cycle.
Borrowers are also waking up to the fact that there's a lot more on offer when it comes to their loan. The Royal Commission into banking and financial services illustrated that the mortgage marketplace extends beyond the Big Four. Customer-owned banking organisations and smaller lenders are providing quality products at a cheap price with all the bells and whistles that homeowners need.
Furthermore, when rates are tipped to fall, lenders will start offering highly attractive fixed rates to entice borrowers into an arrangement before the cash rate drops. Many mortgage holders are now questioning whether to fix their loan now while rates are at a record low or hold out and see what's on offer later in the year.
Those who are planning to fix their rate should have a good reason for doing so. Transitioning from a double to single income household, starting a family or undergoing a change of employment are all situations that require certainty. For homeowners anticipating bigger lifestyle changes such as these over the next few years, fixing your loan is a good way to guarantee certainty around repayments.
But with certainty must come confidence. If you're going to enter into a fixed arrangement, you'll need to adhere to strict criteria. Break costs will be incurred if you decide to exit the loan early, and this can run into the tens of thousands of dollars. You don't want to break that loan for any reason during its fixed-rate term.
Despite the lack of flexibility, there will always be an appetite for the certainty that a fixed rate offers. However, for most borrowers, remaining on a variable rate arrangement is a much better opportunity to get a lower rate over fixing. You'll also be able to reap the benefits of tools like an offset account and the ability to make extra repayments to get a buffer in place.
First home buyers planning to enter the market soon should aim to start out with a variable principal-and-interest loan, rather than an interest-only one. We aren't seeing significant capital gain in the property market, so only paying off interest and none of the principal would be a reckless beginning to a first home buyer's relationship with their mortgage.
The combination of fixed and variable can also be appealing if you want certainty around a portion of your loan, while also enjoying the benefits of a variable rate and all the flexibility attached to it. This way, you enjoy the best of both worlds.
Until the next RBA decision is announced, there is no way of knowing for sure whether the cash rate will drop. However, with all signs pointing towards a cut, homeowners are better off remaining with a variable product for now.
Lisa Montgomery is one of Australia's most respected consumer finance experts and commentators. She is the former CEO of Resi Home Loans and Head of Consumer Advocacy at Wizard Home Loans.
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