Fix, Variable or Split?
When it comes to home loans, there is an increasingly common question I get asked ...
"How much lower can home loan rates possibly go?"
The question is usually followed up by ...
"Where do you think interest rates will go from here?"
The first question is extremely difficult to answer and unfortunately I do not have an answer to it. But if you look around the world, as to how low mortgage rates could go - in Denmark, one of their Lenders started offering home loans with a negative interest rate of -0.5% (1).
The follow-up question is just as difficult to answer and to get a better idea of where Australia's interest rate is currently at and where it is heading, I would encourage you to read or listen to Dr. Philip Lowe's recent address to the Australian Business Economists Dinner about the current interest rate environment (2).
See, it was not that long ago, where the interest rate settings were looking like it was heading in a different direction.
Just late last year, the narrative was very different here in Australia and abroad. It was believed that the RBA's official cash rate was gradually going to rise (3). This held true for the United States as well, where the FED in their December 2018 meeting, raised interest rates for the fourth time in the year to 2.5% (4).
There were a number of domestic Lenders who started to raise the interest rates on their mortgage products and it was cited that the increase was due to an increase in wholesale funding costs (5).
As can be seen, home loan interest rates can go down, stay the same or go up due to a number of reasons. Trying to time and fixing the rate on your home loan to get the "best" deal is extremely difficult and should be avoided for that reason. Instead, we can look at how the different products work, to help make a better decision as to what is right for the individual borrower's circumstances.
Fixed Home Loans
A fixed home loan has the interest rate fixed for a set period of time and begins at the time of settlement. After the expiry of the fixed term, the loan will generally revert to the standard variable rate. Most lenders offer a fixed term of up to 5 years, but some Lenders do offer longer fixed terms.
A fixed loan means that the repayments will not fluctuate during the fixed term, irrespective of whether interest rates were to go up or down, the repayments on your loan will remain the same until the expiry of the fixed period.
- Your repayments are fixed irrespective of interest rate changes.
- The certainty of repayments can help you budget more accurately.
- When you switch or payout your loan (in part or full) a break cost will be incurred.
- The fixed loans are less flexible and limit your additional repayments.
Variable Home Loans
A variable home loan has a floating interest rate and adjusts according to market conditions. The interest rate is determined based on a number of factors including your loan to value ratio, loan amount and whether the repayments are principal and interest or interest only and the purpose of the home loan.
- Paying out your home loan will generally not incur any penalty fees such as the break cost.
- It offers you flexibility and usually allows you to make unlimited additional repayments.
- It is easier to switch into a Fixed Loan without incurring a break cost as you are not locked in.
- Repayments can fluctuate and increase, making budgeting less predictable.
- An increase of interest on repayments could mean that you will pay more in the long run that what you originally anticipated.
Split loans (Fixed & Variable)
A split loan simply offers you split the loan into a variable and fixed facility and into different proportions.
Interest rates can go down, up or stay sideways. Timing it to get the best deal is very risky, difficult and should be avoided.
When thinking about choosing a home loan that is right for you, think beyond about timing the best rate. Instead, think about your lifestyle and financial goals, think about where you are now and where you like to yourself within the next five, ten or even thirty years.
Now that you have decided what type of life you want, configure your home loan product in a way that can help you get there.
Chi Kiet Chau
(1) Collinson, P 2019, 'Danish bank launches world's first negative interest rate mortgage', The Guardian, 14 August 2019, accessed 29 November 2019, <https://www.theguardian.com/money/2019/aug/13/danish-bank-launches-worlds-first-negative-interest-rate-mortgage>.
(2) Lowe, P 2019, 'Unconventional Monetary Policy: Some Lessons from Overseas', Reserve Bank of Australia, 26 November 2019, accessed 29 November 2019, <https://www.rba.gov.au/speeches/2019/sp-gov-2019-11-26.html>.
(3) Reserve Bank Board 2019, 'Minutes of the Monetary Policy Meeting of the Reserve Bank Board', Reserve Bank of Australia, 4 December 2019, accessed 29 November 2019, <https://www.rba.gov.au/monetary-policy/rba-board-minutes/2018/2018-12-04.html>.
(4) Federal Open Market Committee 2018, 'FOMC Meeting', Federal Reserve, 18-19 December 2018, accessed 27 November 2019, <https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20181219.pdf>.
(5) Kadib, C 2018, 'More majors pull interest rate trigger', MortgageBusiness, 6 September 2018, accessed 30 November 2019, <https://www.mortgagebusiness.com.au/breaking-news/12633-more-majors-pull-interest-rate-trigger>.