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Is a fixed rate mortgage the way to go?

Rebeccah Elley

Friday 27 May 2016

Just 5 years ago the average home loan interest rate was sitting at a high 7.27%. Fast forward to present day and it’s dropped considerably to just 4.56% - Saving a homeowner with a $500,000 mortgage (paid back over 25 years), $824 in repayments each month.

Yep it’s a great time to be a borrower! But and this is a big but...how long will this low mortgage rate environment last?

When it comes to variable interest rates there’s no certainty that your rate will remain the same, and depending on what the Reserve Bank of Australia decides to do with the official cash rate (and your home loan lender, who these days can act independently of the RBA) you could see your rate go up or down.

The solution, you might think is simple - “A fixed rate mortgage will protect me against any future rate hikes in the near future!”

While we agree, that fixed rate loans can provide great financial security, there are a few things to weigh up before you decide to lock in your rate…

Here are the major benefits and the downsides of fixing:

FIXED RATE MORTGAGE PROS:

1. Repayment certainty

One of the main reasons to go for a fixed rate mortgage is the certainty that your repayments will remain the same during the fixed rate period. This repayment security is especially important for first home buyers or for those on a tight budget, as it makes budgeting a breeze.

2. Protection against rate rises

Add to this the fact that you are also free of the slap of a higher interest charge during the fixed rate period and locking in your rate could be a smart decision. Just check out this scenario:

Jane has just bought her first home worth $300,000. She works out that she can reasonably afford a maximum of $400 in repayments each week. With the average variable rate of 4.56% her ongoing weekly repayments would be just $387. But say a few months after taking out the loan her lender lifts her variable rate by 0.25%, that would mean her weekly repayments would jump up to $402, pushing Jane over her budget. Whereas if Jane locked in the average fixed rate of 4.22% for 3 years, her weekly repayments would remain at $374 for that entire term.

3. Fixed rates are at record lows

Did you know at the moment, fixed interest rates on average are lower than their variable counterparts? Yep it’s true our database shows the average fixed rate for 1 year is just 4.28%, 2 years 4.16%, 3 years 4.22%, 4 years 4.58% and 5 years 4.61%. Whereas, as mentioned above the average variable rate is 4.56%.

When you consider the previous trend was for variable rates to be lower than fixed, now could be a great time to go for a fixed rate mortgage.

FIXED RATE MORTGAGE CONS:

1. Less flexibility

Lenders might offer you the security of a rate that remains the same over the fixed period but it comes at a price. You’ll have to forgo features like a 100% offset account that helps bring down the interest you pay and a line of credit facility in the case you want access to a revolving line of credit.

Another thing to keep in mind is that while many fixed rate loans now come with an extra repayments facility, there may be caps on the amount you can repay or fees attached.

2. Missing out on rate drops

While we mentioned above that the benefit of a fixed rate mortgage is you’ll be protected against rate increases, of course the same applies on missing out on rate drops. You may regret your decision to lock in your rate if you see your lender drops its variable rates considerably down the track!

3. Break cost fees may apply

To make it easier for borrowers to refinance, break cost fees were banned on variable loans in 2011. Sadly the same can’t be said for fixed rate loans as you may incur a high break cost fee, which is generally a percentage of your loan amount, if you try to switch before the fixed rate period comes to an end.

4. High revert rates

One last negative of going for a fixed rate loan that is definitely worth considering is the revert rate, as the much higher standard variable rate usually applies after the fixed rate period comes to an end.

So if you do go for a fixed rate loan, make sure you’re prepared to refinance when the fixed rate term finishes, by using an online home loan comparison tool, like Mozo’s Switch & Save Calculator.

And the winner is...a split rate loan!

If after reading this, you’re torn between going for a fixed or variable rate, there is a solution to this predicament - splitting your home loan between the two.

How a split rate loan works is you lock in a portion of your loan and leave the remainder variable. For instance, say you decide that the fixed rate will apply to 70% of your loan, then you’ll be protected against any rate rises on that portion and with the remaining 30% that is left variable, you’ll benefit from any rate drops. Plus many lenders also provide partial offset facilities on the variable portion of the split rate loan. An extra bonus of splitting!

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