Weighing up fixed vs variable interest rates: Mark Bouris

Weighing up fixed vs variable interest rates: Mark Bouris
Weighing up fixed vs variable interest rates: Mark Bouris

When official interest rates move, mortgage borrowers have decisions to make.

Broadly speaking, you can stick with a variable rate loan which means paying the best market rate in any given month. Or, you can take a fixed rate mortgage where you lock in a rate for a set number of years.

Neither approach is risk-free. If you fix for three years you risk that during that time the variable rate will become cheaper, and you’ll be paying too much on your loan.

The reverse is that you have a variable rate loan during a time when the Reserve Bank puts up the cash rate, and your mortgage goes up too.

So what should borrowers be doing now?

You should think about two perspectives: interest rates and products.

Firstly, form a view on where interest rates are going.

We can gain insight into this by looking at what the professionals think: the ones to watch are the Reserve Bank of Australia and the banks’ swap rate markets.

The Reserve Bank has been cutting the cash rate since November 2011, and it is now at the historically low 2.75%. Will they cut further?

They’re giving themselves the permission to cut again. The latest decision in June included the statement that current inflation ‘might provide some scope for further easing’.

You have to balance that against the fixed rate market. Several lenders currently have 4.99% fixed loans for three years, which is a good deal compared to the best variable loans which are around 5.3%.

The markets that underpin fixed rate mortgages are the ‘swap rates’ – in the past three weeks they slid from around 3.2% to 2.9%, which indicates banks believe the price of money is dropping.

The job for anyone who wants to fix is to look at the RBA and the swap rates and make a determination as to how low the price of money goes and for how long.

You should also look at products. While variable rate mortgages are fairly simple market-linked loans, fixed rate mortgages have potential pitfalls.

If you take a fixed rate at 4.99%, you want to get further ahead than if you took a variable rate. So you want the lender to allow lump sums on the loan so you can pay it out fast. Many fixed rate loans only allow a fixed payment.

Secondly, watch for break fees on fixed loans. If you sell your home during your three-year term and pay out the mortgage, some loans require you to make good on the income the banks otherwise would have earned.

The third point is to know yourself. Some want the certainty of fixing at a low rate while others want the best market rate in any given month. It’s a personality thing and you should understand where you’re comfortable.

As always, be aware of the forces that work on your finances and be informed. If you’re confused, ask an adviser.

Mark Bouris is executive chairman of Yellow Brick Road, a financial services company offering home loans, financial planning, accounting and tax, and insurance.

Mark Bouris

Mark Bouris

Mark Bouris is executive chairman of Yellow Brick Road, a financial services company offering home loans, financial planning, accounting and tax, and insurance.

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