Homeowners as well as investors have been totally spoilt by the highly competitive home loan market. Those who have taken advantage of the rates on offer from lenders are clearly enjoying the savings they’re making on their mortgage repayments.
Home loan fixed rates currently sit well below the standard variable rates (SVR) so, at the moment, it’s possible to cut your interest costs by fixing. Fixed rate mortgages have their pros and cons. It is important to weigh all options before you make a decision.
According to the Australian Bureau of Statistics in July 2016, fixed-rate loans represented 13% of all new home loan applications, compared with 10% a decade ago. As things stand now, most homeowners still have variable loans, but fixed-rate loans are becoming more popular because of lower interest rates.
According to data from the Reserve Bank of AustraliaOn July 31, 2016, the average fixed interest rate for three years was 4.25 %, which is down from 4.65 a year earlier. This rate is significantly lower that the average standard variable rate of owner-occupier homeowner loans of 5.40%, and the average discounted home loan interest rate at 4.60%.
However, although a fixed rate home loan can offer good protection against rising interest rates, it’s important to consider all aspects of fixed loans which are generally far less flexible than their variable siblings.
Timing is crucial
Clearly, the best time to fix a rate is when variable rates don’t look like they will fall any further in the short to medium term. It’s easy to see why – you only achieve an interest-rate saving with a fixed loan if variable interest rates rise during the term of the fixed loan.
It is nearly impossible to predict interest rate movements, so there is always the possibility of them falling. One inherent risk is that if interest rates fall, you might miss out on a cut in official interest rates and you’re stuck with the rate you locked in at for the duration of your fixed loan. It is possible that you will end up paying more over the long-term.
However, if global economic growth improves, taking with it Australian economic growth, there’s a big chance that interest rates will rise. With a fixed rate, your interest rate costs and repayments won’t rise during the duration of the fixed loan term even if variable rates rise, so this can provide additional peace of mind.
So, all things considered, fixed loans are like a form of insurance that your interest payments won’t go up or down during the fixed term – but you may pay a premium for that insurance and peace-of-mind. Fixed rates can incur “Lock-in-Costs” which range from $500 – $750 per application on average.
There’s more you should consider before fixing the loan too. These other factors should be considered before you contact your broker or financial lender.
Most home lenders do not allow additional repayments on fixed loans. Some lenders don’t allow any extra repayments at all, while others will allow extra repayments up to a certain limit, often $10,000 or $15,000 a year. You can rarely pay more than $25,000 extra on a fixed loan, so asking your lender what limits they put on extra repayments is worthwhile, because if you pay beyond that level, you’ll be hit with penalty fees.
If you do repay a fixed loan off early, that is, before the end of the fixed term, you’ll have to pay break costs, which covers the lender’s economic loss – essentially because the lender won’t make their forecasted margin on the loan.
Break fees can reach thousands. Lenders will pay back any loss if the variable rates drop during the loan term. Before you make repairs, be aware of these costs.
You can also look into the offset option
On top of break costs, you also need to be aware that in general, fixed loans generally don’t have offset facilities, which are common on variable loans.
The balance in your savings account can be used to offset your home-loan balance, which will reduce your interest costs. This will lower interest costs and allow you to have easy access your money. Some lenders offer partial interest-offset accounts to fixed loans. Find out what your lender has available.
Split mortgages let you fix a portion of your loan while leaving the remainder at a variable rate. This provides some protection against rising interest rates, as well as flexibility for additional repayments on a variable portion.
Split loans are a great option for those who want the security of regular repayments. Split loans offer additional benefits, such as the possibility to repay the loan early and make as many payments as you like without penalty. This provides some protection from rising interest rates through the fixed part of your loan while still allowing flexibility with the variable portion.
There’s a myriad of lenders in the market with a broad range of products available, so choosing a home loan can actually be more complex than it used to be. Lenders are becoming increasingly competitive and often they’ll be happy to discuss options with you, so you should get all the facts up-front to avoid surprises later.
It might be worthwhile to consider hiring a broker for home loans. They’ll scour the market for you to obtain a competitive loan and one that suits your circumstances. They can also be very knowledgeable and help support you through your application – often negotiating with the lender on your behalf. One benefit of using a broker is that it’s their business to remain up-to-date with the ever changing and increasingly complex and competitive home loan market. Your bank typically covers the cost of using a brokerage. It is important to disclose the fees charged by brokers. This could include a percentage from the loan amount. This provides transparency regarding the service cost.
There are many options. You have options. Make sure you fully understand your home loan. If you’re unsure of which way you should go, talk to your lender or engage the services of a broker so they can guide you through the options you should consider.
General Advice Disclaimer: The information contained in this article is general in nature only and does not constitute personal financial advice. This article was not prepared taking into account your financial goals, financial situation, or needs. It is important that you evaluate the accuracy of this information taking into account your financial goals, financial situation, as well as other needs.
About Jason Dunn
Jason is the GM Strategy & Distribution for Anne Street Partners Financial Services. Anne Street Partners hired him in February 2015. He has nearly 30 years experience in finance, and more than 20 years of senior leadership and executive experience. Jason was previously Head of St. George Bank of Melbourne. He was a Westpac Banking Group veteran for five years and implemented and delivered many programs, including the National Westpac Financial Planning Customer Valu Program Director and State head Westpac Business Financial Planning.