Is now a good time to fix your loan?

If you are thinking of fixing your mortgage, the numbers have recently been in your favour, but don’t take the leap until you’ve assessed your situation.

Much of the literature out there that looks at whether or not you should fix your mortgage talks about paying an extra price, in return for the reassurance that you will be paying the same amount each month for the fixed period. The thing is, much of the literature out there was produced during times when lenders were offering fixed rates set higher than the current standard variable rate. For many people, such a scenario made their decision black and white: fix your interest only if you believed a further rise in standard variable rates would jeopardise your ability to pay off your mortgage and then, only if you were sure that you wouldn’t need to sell your house or break the agreement during that term.

Nowadays, fixed repayment rates for home loans are averaging nearly a whole percentage point lower than standard variable rates. This introduces a new element to the argument. You may be motivated by certainty and security when making the call, but also enticed by truly beneficial savings value.

According to statistics from the Reserve Bank of Australia (RBA), three-year fixed rate offers from lenders averaged 6.10% in June 2012, compared to a standard variable average of 6.85%. This is a healthy gap of 0.75%, but just six months earlier the gap was 0.95%, the largest half-year gap between the rates in more than a decade. As the gap begins to narrow, it appears more likely that fixed rates are bottoming out. Even so, they are currently tracking 95 basis points below their 10-year average, meaning that you will get a better than average deal by fixing now, regardless of whether they drop again or begin to rise.

Short term savings

Comparing the June 2012 averages and assuming you are taking out a loan of $400,000 with a repayment term of 30 years, you will pay $2,621 per month at a standard variable rate of 6.85%. This works out to an approximate total of $94,357 for the first three years of the loan.

If you lock in a three-year fixed rate of 6.10%, you will pay around $2,424 per month, which totals around $87,263 for the fixed period. This is a saving of $7,094 over the three years, assuming that the standard variable rate remains the same.

While the following table shows that historically there is little chance of the standard variable rate spending three years at the same average, the current climate suggests it is unlikely to drop significantly enough to bring it close to the fixed rate in the near future.

Source: RBA

Many people prefer to focus on a long term average of the standard variable, rather than its current average, when calculating whether fixing is worth their while. The average standard variable rate over 10 years is 7.31% according to the RBA, which, using the same specifics as the above examples, would translate to monthly mortgage repayments of $2,745. This would total approximately $98,820 over three years, around $11,557 more than you would pay with a current fixed rate.

As it currently stands, the standard variable is lower than its 10-year average, and also lower than its 20-year average of 7.82%. It is well below its 50-year average of 8.98%, which was pushed up by rates as high as 17% during the early 1990s.

Meanwhile, the average fixed rate over the past decade sits at 7.05%, while over 20 years, it averages 7.79%. This would suggest that fixed rates have more room to increase from their current position than they do to drop.

Getting into a fix

If you love flexibility in your home loan repayments, then it may never be the right time for you to fix. According to ING Direct’s Financial Wellbeing Index, around 48% of home loan borrowers make extra repayments on their loans. They do this to create extra funding that can be called on in emergencies and also to speed up the repayment of a loan.

You may not realise, but the compound interest you pay during the life of a loan is often more than the loan itself. For example, a $300,000 loan at a standard variable rate of 7% accumulates an extra $418,500 in interest over 30 years. This means you pay a total of $718,500 on your $300,000 loan, at monthly installments of around $1,996.

If you decided to round up your monthly repayments to $2,050 (or around 7.25%) instead, you would cut $25,000 off your interest bill.

Many people believe it wise to pay extra money into their home loan instead of into a savings account, because in the long run, they will save more. If they fixed their home loan repayments, they would not have this option. While some fixed loan products allow extra repayments up to a minor amount, you are usually locked into a structure that is far less flexible than the many standard variable products on the market.

Everything’s fined

In July 2011, the federal government abolished exit penalties on new home loans. As a result, fixed interest loans are the only products where your bank can sting you with costly penalties for leaving early. If standard variable rates plummet, or you suddenly need to sell your house, early break fees (EBFs) can set you back tens of thousands of dollars. The fees include a relatively small administrative cost, in addition to a much larger amount, which aims to compensate your lender for the loss of the money that would have been accrued over the remaining period of your fixed loan term.

Best of both worlds

If you are attracted to elements of both fixed and variable rates and want to hedge your bets, many lenders now offer split products. Through such loans, you are able to fix a portion of your loan and leave the rest up to the fluctuations of the variable rate market. You can nominate the size of the fixed portion according to your risk appetite and continue to enjoy the flexibility of the remaining portion, by making extra repayments, redrawing and offsetting.

To discuss this article or anything to do with your finances, please call our office today and we will be happy to assist you.

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