Fixed interest rates are still at record lows

Teachers Mutual and Adelaide Bank are offering fixed rate home loans  with a 100 percent full transactional offset account – this is a fixed rate loan with virtually none of the restrictions you would normally expect ( short of paying out the loan)….. you really have to be interested in this.

Fixed interest rate home loans, what are the risks

Yes variable interest rates may fall further – but how much further. So what are the risks of fixing:

  • The most important thing to remember is that fixed interest rates, unlike variable rates are not directly linked to the RBA cash rate. It is not unusual for fixed interest rates to move in completely the opposite direction. What’s more fixed interest rates can move at any time, there is generally very little warning especially of an increase – at best you may have 48 hours to arrange a rate lock (see below).
  • break costs apply if you repay all or even part ( varies by lender) of the debt during the fixed rate period. See below how these fees are calculated – but the reality is current fixed interest rates and by association the cost of borrowing to the lenders are at all time historical lows and break fees only apply if the rates stay low. If the rates are equal or higher then there is no break fee and so you have to ask yourself, what is the chance that in the future rates will be even lower and what is the chance that you will be forced to break.
  • fixed interest rate loans lack flexibility – this can be true but we have lenders who offer amazing flexibility while almost all lenders will allow you to split your loan into a part fixed interest and part variable interest and thus you get the benefit of both.
  • the fixed interest rate is not guaranteed unless you arrange a rate lock. With most lenders the rate that will apply to your mortgage is the rate that is published on either the day the loan settles or may be the day the mortgage documents are drawn up. For many borrowers this is weeks after the application is lodged and therefore most people will take the ‘rate-lock’ option which guarantees that the rate which applied on the day you locked will be valid through to settlement ( usually 90 days, but for some lenders 60 days ). Most lenders will charge a fee of around 0.15% of the loan amount while others charge a flat $750 and yet a few others offer you a free 90 day fixed interest rate lock. Beware of some lenders whose rate lock applies even if the rate falls – you pay the higher amount, obviously we don’t recommend these lenders.

And so the reality is for many people, at this time the risks appear to be worth the gain which at the very least would be the ability to sleep at night. That probably explains why so many of our clients with large borrowing are rushing to fix their home loans. None the less fixed interest rates probably aren’t suitable for everyone such people working with insecure tenure eg: casual or people considering starting a new business etc.

Fixed Rate Checklist

Before you commit to a fixed interest rate home loan ask yourself:

  • Is it important to have certainty on the amount of your monthly repayment?
  • Have you considered the possibility of major changes to your family arrangements eg: maternity, your job or your business?
  • What are the chances of selling your property any time within the fixed period?
  • Thinking of buying an investment property – this can be an issue?
  • Will you be in a position to make additional repayments over and above your monthly repayments?

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Why not have part fixed interest rate and part variable rate

That’s right you can spread the risk or maintain the flexibility of variable rates by splitting your home loan to part fixed interest rate and part variable rate. ME Bank (Members Equity), CBA, ING, Suncorp, Westpac and St George all offer good split loan options under their packages. But with some lenders you don’t have to split eg: the current offer from Adelaide Bank of fixed rate home loan with 100% offset account on the fixed rate account and free 90 day rate lock is very attractive and Heritage still allow unlimited repayments with redraw – check our split loan calculator.

Trying to pick the right time to have a fixed rate on your home loan can be difficult but that is not really true at the moment. Normally only around 20% of fixed rate loans turn out to be cheaper than they would have if they had stayed with a variable rate home loan. That’s because it is so difficult to predict the future with any degree of accuracy, however at times of uncertainty as long as you have good income security fixed rates can offer an appealing piece of mind. Keep in mind that 3 years ago variable rates were over 8% and you would have jumped at a fixed rate home loan of 7.50%.

Ultimately the time to fix the interest rate is the time when ‘you’ feel comfortable with the fixed rate being offered. Keeping in mind they may fall further – don’t kick yourself for missing out on that, be happy in the knowledge that you are safe from any increases in the rest of the fixed rate term.

 

Early Repayment Fees – Economic Cost – Break Fees on Fixed Rate Home Loans

In Australia all lenders, that we are aware of, recover the economic cost when you discharge, refinance, or make substantial repayments on a fixed rate loan. They can also apply if you are in default. How this fee is calculated varies and the calculation can be complex, however in general terms it is based on the lender’s cost of funds (not the current standard variable rate) at the time you enter into the fixed rate period. This is then compared to the cost of funds at the time the break fee is calculated. If interest rates have increased it is unlikely there will be any economic cost, since the fixed rate will be lower than the current cost of funds rate. However if rates are falling the lender is losing out since they can only re-lend your funds at the current lower rate. They would argue that they borrowed at the higher rate and so are entitled to recover the difference that they would have made if you kept the loan for the fixed rate period. (See our head brokers take on this subject)

The following chart shows an example of the economic cost in $ for every $1,000 to which the fee applies. So for example if cost of funds fall by 2% and you have $200,000 fixed for another 24 months – the break fee will be $8,000 – (this is an approximation).  You can only find the actual figure by telephoning your lender and asking for a quote at today’s date.

Fixed rate home loan break cost examples

 

Period in Months to Expiry

Rate Movement

6

12

24

36

1%

5

10

20

30

2%

10

20

40

60

3%

15

30

60

90

4%

20

40

80

120

5%

25

50

100

150

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Finally a word on comparison rates

By regulation comparison rates are based on the life of the loan being 25 or 30 years. And while this is intended to provide you the borrower with a levelled playing field to compare products and lenders, it usually creates a distorted view especially when comparison rates are applied to fixed rate home loans. This is because at the end of the fixed rate period most loans revert to standard variable, which at the moment is much higher than most fixed offerings. Even if you have a package discount the lender cannot take that into account as it assumes that you have paid the annual package fee into the future, where as if you fail to pay the package fee the standard variable applies and so where a discount is dependent on discretionary options they must use the full standard variable.

Furthermore the regulation comparison rate does not allow for the option of re-fixing, or switching or in fact refinancing at the end of the fixed period. Which is exactly what every mortgage broker would normally recommend that a borrower should do if confronted by high standard variable rates. So to get a true comparison we suggest you do the comparison rate calculation based on the 3 or 5 years that you chose to fix this is called the AAPR – the average annual percentage rate which is what the comparison rate was based on but failed to emulate.

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