At its September meeting the board of the Reserve Bank decided that it was still a little bit early in Australia’s economic recovery to push interest rates up. But make no mistake about it – the cash rate will not stay at its current “emergency” level of 3 percent for much longer.
And the big banks have already shown that they won’t necessarily wait for the nod from the RBA to send their home loan interest rates higher. For several months they have been quietly pushing up their fixed home loan rates in anticipation of an official increase.
So where does that leave you, the borrower? Is it too late to find a competitive fixed rate deal or are you better off riding out any change in variable mortgage rates?
Unless you have a crystal ball it is difficult to know for certain what will happen to interest rates in one, three or five year’s time. Fixing all or part of your home loan can give you the certainty of knowing what your repayments will be regardless of what happens to the cash rate.
For example, let’s take a punt and presume official interest rates will increase by 2 percent over the next two years. Assuming lenders pass on the whole 2 percent increase to their customers, the best variable rate would be 6.79 percent p.a. compared to today’s best rates.
The most expensive variable rate home loan would be up around 8.34 percent and the benchmark variable rate (the average of the big four banks) would be priced at around 7.25 percent.
Those figures make some of the current two and three-year fixed rate deals look comparable. Gateway Credit Union is currently offering 5.99 percent p.a. for two years and MECU’s three-year fixed rate is 6.49 percent p.a.
If you fixed your whole loan – let’s say $250,000 – at 6.49 percent for three years, your monthly repayments would be set at about $1,686. If, on the other hand, you stuck with your variable rate package and rates increased 1 percent after 12 months, and then another 1 percent a year later, after three years you would have paid $3,244 extra with the variable loan.
A bet each way
If you’re worried that rates are going to keep rising for the next few years but still want to benefit from the current low rates for as long as they last, one option may be to split your loan between a fixed and a variable rate.
MECU, Gateway and Reduce all offer the option of splitting your loan between the three-year fixed and variable rates.
Fixing all or a portion of your home loan usually means you will have to accept less flexibility. Additional repayments may not be allowed and many fixed loans don’t come with mortgage offset accounts. Some don’t allow you to make additional lump sum repayments.
And if your crystal ball predictions are wrong and interest rates don’t move in the direction you think you are going to, fixed rate home loans can have a nasty sting in their tail because of break costs.
If you want to get out of a fixed rate deal early because, for example, rates have gone down, the lender will charge you the difference between the interest rate you’ve signed on for and the rate at the time you break the loan multiplied by the loan amount.
Each lender has a slightly different way of calculating break costs so read your contract carefully and do some calculations to make sure you know how much you might be up for.
Fixed rate home loans are generally more expensive compared to current variable rates as you’re paying for the insurance of a steady rate that won’t rise during the fixed period. They can be handy for those on a tight budget but if variable rates drop while you’re locked in to a higher rate, you could miss out on significant savings.
That is why it’s so imperative to compare home loans and read the product disclosure statements (PDS) to make sure the loan is right for you.