With interest rates rising, a question I am regularly asked by clients is, “should I fix my home loan interest rate, or is it better to stay variable?”
The answer is that it depends on your situation & whether fixing the rate, will provide greater certainty and peace of mind.
However, whilst fixing your rate may provide peace of mind, there are some potential downsides to consider.
How high will interest rates go?
The Reserve Bank raised the cash rate by 0.50% to 1.85% at their August Board meeting.
The major Banks are forecasting the cash rate will increase to between 2.1% to 3.31% by the end of the current year. One Bank is also forecasting a further increase to 3.35% in February 2023.
Predicting interest rate movements is difficult, as rates are influenced by such a wide range factors, both in Australia, and offshore.
To illustrate how difficult forecasting can be, as late October 2021, the Reserve Bank with all their resources, predicted rates would not rise until 2024.
We have also recently seen one of the major Banks reduce their 4-year fixed interest rate by 1%, suggesting they now believe rates will not go as high as they had anticipated.
All of this does not make the question, “should I fix my home loan interest rate”, any easier to answer!
However, based on current information, it seems there will be further rate rises between now and the end of the year, then start to ease in 2023.
Why is the cash rate increasing?
The Reserve Bank is raising interest rates to combat inflation which was running at 6.1% in the June quarter and is expected to peak at around 7.75% by the year end. (They then expect it will reduce to a bit over 4% in 2023 and 3% in 2024)
The theory is higher borrowing costs mean people and businesses, will have less to spend. This in turn will dampen demand and curb/reduce inflation.
If everything works as expected, as inflation comes down, interest rates will follow.
Why the cash rate is different to a home loan rate
The cash rate has an indirect impact on the rates charged by Lenders. It is the minimum rate Lenders must pay when they borrow from each other. Other factors that influence the actual rate you pay include:
- The Banks funding costs (what it pays on deposits and/or to borrow funds from other institutions)
- The risk margin they apply (people with good credit ratings, income and equity may enjoy lower risk margins)
- Their profit margins
- The Bank’s outlook on interest rates
- Competition
The benefits of fixing your interest rate
The key benefits of fixing your interest rate are:
- Greater certainty because repayments will not increase for the period the loan is fixed
- Protection should rates rise above your fixed rate
Whilst this is great, bear in mind Lenders have already factored potential interest rate increases into the rate you receive. This is the reason fixed rates are higher than variable rates.
The decision to fix comes down to how much certainty you want and whether you believe rates will increase beyond the fixed rate you will be paying.
Disadvantages of fixing interest rates
When deciding, should I fix my home loan interest rate, it is important to be aware of potential downsides which include:
- The break costs can be significant if you need to sell your home, restructure, or refinance during the fixed rate period (The reason for this is, when you lock in a rate, the Lender will enter a contract with another party to offset their cost for the period – if you break the contract, they pass the cost on to you)
- You may not be able to make large extra payments during the term without incurring penalties (some Lenders will allow extra payments up to an agreed level)
- You may not have access to Loan Redraw options or be able to use Offset Accounts
- Should interest rates fall during the term, you could be paying above market rates until the fixed rate term expires
Split Loans
If you’re wondering, should I fix my home loan interest rate, one option may be to split your loan, which means you have:
- Part of the loan variable
- Part fixed
The advantages of splitting the loan being:
- You know that the cost for part of your loan, will not increase during the period the rate is fixed
- You can make extra payments on the variable portion without worrying about penalties
- You may be able to enjoy the benefits of Account Offset and/or Loan Redraw on the variable portion of the loan
The major disadvantage of a Split Loan is the potential to incur break costs on the fixed loan, if you need to restructure your borrowings, or sell the home, during the fixed rate period.
Summary
Recent sharp increases in interest rates have left many borrowers wondering, “Should I fix my home loan interest rate?”.
This is understandable given we have experienced a long period of stable, very low interest rates, followed by a series of rapid rate increases.
Whether to fix is very much a personal decision and will depend on your individual circumstances.
If you would like to learn more about the options available, don’t hesitate to get in touch.
As a Finance Broker, I have access to over 40 Lenders, including all the major Banks. Highly competitive rates are still available – both fixed and variable.
