Fixed and variable conundrum remains as longer term outlook for interest rates remains cloudy

Borrowers on variable rates can pay off their home loan 10 years early if they don’t adjust repayments and put an extra $300 per month into their home loan every month, says mortgage comparison website RateCity.com.au.

However, mortgage broker Smartline advises that taking out a three year fixed-rate loan at 4.99% currently saves around $5,500 per year - and savings would be greater if mortgage rates were to start to rise in the next few years.

Rising interest rates will also make it harder for borrowers on variable rates to stay ahead of their mortgage repayments.

Much will depend on where interest rates head over the next few years.

Currently, major bank economists are tipping a rate cut to 2.5% in August, but the outlook beyond that is uncertain.

The most recent Bloomberg survey had a median forecast of a 2.75% cash rate by the end of 2014, but with forecasts ranging from as low as 2% to as high as 3.75%.

With this level of uncertainty, borrowers could also consider splitting their home loan between fixed and variable – and hedging their bets.

Analysis of the RateCity.com.au database of more than 100 lenders found that the average standard variable home loan rate has fallen by 1.62 percentage points from 7.31% in November 2011 – when the RBA began cutting the cash rate - to 5.69% in July 2013.

Variable rate borrowers with a typical $300,000 home loan who keep their monthly repayments at the November 2011 level of $2,059 are paying more than $300 per month above what they are required to pay.

If they continue this trend and add an extra $300 to a $300,000 mortgage each month, they would potentially save over $151,000 and shave nine years and five months off a 30-year home loan (based on the historical average standard variable rate of about 7%).

“Many Australians have taken a new approach to borrowing, which could see a whole generation of mortgage holders paying off their home loan a decade early,” says Michelle Hutchison, spokesperson for RateCity.

“Even though the cost of a mortgage rises when rates increase, it’s worth adding as much as you possibly can to your mortgage, particularly when rates are low."

A separate study by Smartline Personal Mortgage Advisers found that mortgage holders who choose to lock in their home loan at below 5% could save up to $5,500 a year.

Smartline calculated the potential saving based on the rates on offer when compared with long-term average interest rates using fixed and variable offerings of an unnamed major bank.

Over the past 14 years, the bank's basic variable interest rate has averaged 6.85% per annum.

This same major bank is currently offering 4.99% for a three-year fixed rate. A saving of 1.86% p.a. on the 14 year variable average equates to a saving of about $5500 p.a. on a $300,000 mortgage.

“This is the very reason why a third of our clients are taking out fixed rate loans,” says Smartline mortgagebroker Michael Daniels.

“When you crunch the numbers on the savings, it’s a pretty compelling argument. 

“There are many more who are considering a fixed rate, but who don’t want to lock themselves into a fixed rate in case rates drop further. It’s probably the question Smartline Advisers are asked the most these days – ‘will they go lower?’. 

“While fixed rates might drop a little bit further – but I wouldn’t say it’s a certainty – the fact is that the fixed rates currently on offer are historically low. 

“Cheap is cheap – most people should be delighted to be paying something like 4.99% when compared with the long-term average variable rate of nearly 7%. 

“When fixed rates go up they move quickly, generally faster than they come down. You won’t kick yourself for locking in at 4.99% but you might if you suddenly find they’re back up past 6% again.” 

However, while the potential savings are significant, Daniels says people need to consider their own personal situation and whether locking into a fixed rate is the best approach for them.

Early exit fees still apply to fixed rate loans and these fees can be substantial.