Fixed versus variable mortgage conundrum for borrowers as major banks differ on 2013 cash rate outlook

Divergent cash rate forecasts from the major banks are providing new or refinancing borrowers with little guidance in deciding whether to opt for a fixed-rate mortgage and insulate themselves against future rate rises or choose a variable-rate offering and benefit from lower monthly repayments if rates fall.

A third option – splitting the loan into part-fixed and part variable – is also something for borrowers to contemplate.

According to the latest Bloomberg survey of economists, the most bullish of the major banks is Westpac, led by chief economist Bill Evans, which expects another 75 basis points trimmed from the cash rate between now and March 2013 to a record low of 2.75% and then expects the cash rate to remain at that setting over the course of 2013.

“We retain our view that there will be two rate cuts in the December quarter followed by a further cut early in 2013,” said Evans last week following the RBA’s decision to leave the cash rate unchanged at 3.5% on September 4.

Most bearish is NAB, led by chief economists Alan Oster, which does not expect any more cash rate cuts in the current cycle, with the cash rate remaining at 3.5% for the first six months of 2013 and then rising to 4% by year-end.

ANZ, led by chief economist Warren Hogan, expects 50 basis points to be cut over the same period, taking the cash rate to 3%, and Hogan also expects it to remain unchanged over 2013.

“Overall, our views on the Australian policy outlook and economy are largely unchanged. We continue to expect the RBA to end up changing its mind about interest rates, probably by November,” said ANZ economists Ivan Colhoun and Justin Fabo last week.

The Commonwealth Bank, led by chief economist Michael Blythe, expects one more rate cut in the final quarter of 2012 based on downside risks “emanating from Europe and the global economy generally” taking the cash rate to 3.25%, where it is expected to remain over 2013.

The confused picture comes as lenders continue to cut their fixed-rate mortgages in an effort to entice cautious borrowers, with the Commonwealth Bank the latest to trim its suite of fixed-rate offerings.

In August Mortgage Choice reported a marked jump in the proportion of borrowers who took out fixed-rate loans to nearly one in five in the month and attributed this to attractive reduced rate offerings and a penchant for borrowers to be conservative in their choice of home loans.

A survey of Sunday Herald Sun financial commentators found them divided over which strategy – fixed or variable – borrowers should adopt, with the majority in favour of a split loan option.

According to Lisa Montgomery, CEO of mortgage lender Resi, while low fixed-rate mortgage offerings can seem attractive, borrowers should be aware of the hidden traps including huge costs if they break the contract – the government ban on exit fees only applies to variable-rate mortgages taken out after July 1, 2011.

Other traps in fixed-rate home loans – besides the obvious one of not benefiting from lower interest rates  should the cash rate fall – include not being able to pay down additional amounts and pay off the mortgage earlier.

But the benefits of a fixed-rate loan, says Montgomery, include peace of mind for budgeting, protection from rate fluctuations and rates now at five-year lows.

Aussie Home loans founder John Symonds, a long-time supporter of variable rates, says currently low fixed-rates would be very tempting to borrowers at the moment.