Five year fixed rates from 5.55%
In recent weeks there have been a number of lenders cutting their fixed rates. A recent report showed that 26% of home loans were fixed in March, up from 20.6% in February and well above the 12-month average of 17.7%.
With rates near record lows there is temptation to lock rates in. But will this actually be the best move and are the savings really there? Before fixing there are a number of things to consider.
Variable rates remain competitive
There are currently variable rates available from 5.32%. So fixing at 5.55% may be fixing 0.23% above what you can access in the variable market. On a $300,000 loan this would mean $690 a year more in interest. If rates fall by another 0.25% then this would mean an extra $1440 per year in interest.
And here’s the catch your breakeven point is not when variable rates reach 5.55%. The breakeven point is actually higher. Let’s say you fix at 5.55%, the variable rate is 5.32% and rates fall by an average of 0.25% in the first 12 months, rise by an average of 0.25% in the second 12 months. Based on the numbers above that would mean at the end of year 2 you have paid $2130 more in interest. If in year 3 rates increased by 0.25% to 5.57% you are only ahead by $60 per annum. If in year 3 rates increased by 0.5% to 5.82% then you would be saving $810 in interest but would still be $1320 behind by the end of year 3 and $510 behind at the end of year 4 if rates averaged at this level.
Remember banks are very good at making profits. They don’t set fixed rates on the basis of losing the bet. They are betting you will end up paying more interest under the fixed rate than if you stayed on variable.
No one actually knows what will happen
Recent history has shown how difficult the movement of rates is to predict. Let’s look briefly at cash rate movements over the last two rate cycles.
Dec 2001 4.25% (Bottom)
Dec 2006 6.25% (5 year mark)
Mar 2008 7.25% (Peak)
Sep 2008 7.00% (First cut)
Apr 2009 3.00% (Bottom)
Oct 2009 3.25% (First increase)
Nov 2010 4.75% (Peak)
Nov 2011 4.50% (First cut)
Dec 2011 4.25% (5 years)
Apr 2013 3.00% (Current)
Penalties can be into the thousands if you have to exit a fixed rate loan at the wrong time. Remember the timing of exiting a loan may not be of your choosing
Loss of flexibility
Generally there is limited scope to make large lump sum reductions during fixed period - eg you could be on a low rate but can't pay off the loan any faster . Also generally no access to redraw - what if you need those funds for a rainy day?
Also most fixed rate facilities do not offer genuine 100% offset accounts.
What if you require extra funds and the bank says no. You might be forced to refinance and get a nice big penalty on the way out. A realistic proposition in the current market with lenders tightening their policies.
Statistics indicate that Australian households are currently focused on saving rather than spending with many Australians being in advance of their home loan repayments. Indications are that many households maintained repayments at the same level as rates have come down. Maintaining this approach might be a more flexible option than locking yourself in.