Is it time to fix your mortgage?
Whether to go for a fixed or variable mortgage interest rate is one of the bigger decisions all mortgage applicants have to decide on. It’s an important decision to get right at a time when the differential between fixed and variable interest rates is significant, whilst the break fees on fixed interest rate mortgages are also significant. Both the mistakes of over-paying interest and paying break fees are painful ones for property buyers, so read on below for the best way to keep your bank payments to a minimum.
Let’s start with why you may consider fixing your interest rate. The main benefit of fixing your interest rate is in securing a low interest mortgage which will remain fixed if and when interest rates increase in the coming years. At the time of writing this article, the fixed interest owner-occupier mortgage rates available are well below 2%. This situation would have been considered extraordinary a few years ago. And the available comparable variable mortgage rates are generally around 20-100 basis points higher, so they remain attractive albeit not quite as attractive as fixed rates.
Input from the Reserve Bank of Australia (RBA) is also clearly relevant to this decision. At the last RBA meeting a few weeks ago, RBA Governor Philip Lowe confirmed that they expect official interest rates to remain at current low levels, at least until 2024:
‘Further progress in reducing spare capacity is expected, but it will be some time before the labour market is tight enough to generate wage increases that are consistent with achieving the inflation target. The Board does not expect these conditions to be met until 2024 at the earliest.’
So, whilst benefits of fixing are clear, fixing may not result in a significant interest rate savings in a lower for longer interest rate environment since variable rate mortgages are also likely to remain attractive. And the other key point to bear in mind is that fixed interest mortgage break costs can be significant. Typically, they represent the interest differential versus what the bank could achieve on the same product at the time of breaking for the remainder of the term. For example, on a $500,000 mortgage, the break fees could be as high as $5,000 or more.
Landen’s Director Jim Dionysatos offers his views on how to potentially strike an effective balance in this decision when investing in newly constructed homes:
‘Given most banks prefer to fund home construction with variable interest rate loans, a lot of our most astute clients are splitting their loans between fixed rate loans for the land purchase, and variable rate loans for the new home construction. And the variable rate loans they are choosing generally have offset accounts attached which allow them to effectively pay down their mortgage whenever they want. This strategy provides a balance between securing the cheap fixed interest payments as well as all the flexibility benefits variable interest mortgages offer. And it allows investors to start paying down the variable rate component of their mortgage funding by transferring any savings into their offset account. In turn, they’re able to use the accumulation of funds in this offset account to pay for the deposit on their next property purchase. It a virtuous cycle.’
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