Don't fix if you are thinking of selling your home and 4 other fixed-rate traps to avoid

Don't fix if you are thinking of selling your home and 4 other fixed-rate traps to avoid
Larry SchlesingerDecember 7, 2020

While mortgage exit fees have been banned on variable home loans for more than two years, hefty break costs may still apply if you exit a fixed-rate home loan before the end of the agreed term of the loan.

This is something borrowers need to keep in mind, particurlarly if they think they may sell their home before the end of their fixed-rate term.

Selling your home and exiting a fixed-rate mortgage early will not protect you from break costs and lenders will calculate an “early repayment adjustment” to recover their funding costs.

Depending on what has happened to interest rates since the loan was taken out, the size of the loan and the length of time remaining in the fixed-rate term, break costs can range from a few hundred dollars to many thousands of dollars.

Financial products data provider Canstar estimates that the break costs on a $250,000 three-year fixed rate loan that still has two-and-a-half years to run would be around $10,300.

At the same time enticements to take out longer fixed-rate home loans are greater with lenders cutting interest rates on three and five year fixed rate home loans.

These include ME Bank, which last month cut its five-year fixed rate to 5.49%. In May Citibank cut its five-year fixed rate to 5.35%.

Five-year fixed-rate home loans account for around one in five fixed-rate home loans taken out by borrowers with three-year fixed-rates the most popular (two-thirds of all fixed-rate home loans taken out in Australia), according to finder.com.au.

While the cash rate is tipped to fall next month to 2.5%, if you take a view that rates will rise over the next five years, a fixed rate of just over 5% may sound tempting.

But be aware that break cost can run into the thousands of dollars if you decide to sell your home within the fixed rate term.

Here are four other fixed-rate traps to avoid:

  • Not being able to pay off your home loan sooner if your financial situation improves

While fixed-rate home loans provide certainty around future mortgage repayments and help with budgeting, if your financial situation improves, the terms of your loan may restrict you from making extra repayments or additional costs may apply. In essence, the interest rate is not the only factor to consider when taking out a fixed-rate home loan. In addition higher monthly and annual fees and costs may apply.

  • Not splitting your home loan

Borrowers that take out their entire home loan on a fixed-rate will lose out on any interest rate cuts. However, if they split their home loan between fixed and variable, they hedge their bets, meaning some upside if rates fall and some protection if rates rise. Many lenders will allow borrowers to choose how much of their home loan they wish to fix and how much they wish to borrow on a variable rate.

  • The fixed-rate rollover trap

According to Mortgage Choice, many borrowers would not be aware that at the end of a fixed rate the loan rolls over into a standard variable rate, which is usually 0.7% higher than the cheaper basic rate loan and could result in your mortgage repayments rising. Usually borrowers can negotiate a better deal with their lender, but this requires that you be vigilant as to when your fixed-term ends and have maintained a high credit rating.

  • Missing out on attractive offerings during your loan term

Taking out a fixed-rate home loan at what seems like an attractive rate may seem like a good idea, but if attractive variable or other fixed-rate mortgage offerings come to market, you may not be able to take advantage of them because you are locked in. The key is to be certain about the loan product and length of the fixed-rate term.

Larry Schlesinger

Larry Schlesinger was a property writer at Property Observer

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