Should you fix your mortgage (now) or stay variable?

When Interest Rates Rise?

Just in case you missed it, at the end of last week a couple of the major banks and several second tier and smaller banks, significantly raised their Fixed Interest rates – some increased fixed rates by nearly 0.6% (for 5 year fixed rate loans). The others are likely to follow soon. Given fixed interest rates are often a leading indicator of future variable rates, this is something all Generation Xer’s with a mortgage should sit up and take notice of.

Mortgage interest rates are historically the lowest that they have ever been. Such a significant shift in the fixed interest rates signals that we may well have reached the bottom and you should be seriously considering whether or not it is right for you to stay variable or fix your mortgage…and if you choose fixed, then how long for?

Personally I am a believer for fixing my mortgage interest rate. And when doing so, choosing to fix for between 3 to 5 years. To me, fixing for 1 or 2 years is a waste of time. Many people whose financial opinions I respect would disagree with me on the virtues of fixed rate loans…and that’s OK. The world would be a very boring place if we all had the same opinions. Call me a bit of a control freak but I like to have certainty where possible. A fixed interest mortgage provides cash flow certainty…at least for the duration of the loan.

There are a few key pros & cons when considering whether fixing your interest rate on your home and/or investment property mortgage is right for you;

Pros

  • As above, cash flow certainty. You know what your repayments are going to be for the life of the fixed loan, even if the Reserve Bank increases interest rates. You can plan how to allocate your cash flow towards current living, debt reduction and wealth creation strategies over the duration of the fixed loan…without having an interest rate hike or two derail your plans.

Cons

  • Fixed loans are inflexible and can have high break fees (often several thousand dollars) if you need/want to break the loan during the fixed term (e.g. if you were to sell your house or look to refinance).
  • Fixed loans have limitations on the amount of extra repayments you can make over and above your contractual loan repayments (e.g. usually no more than around $10,000 per year extra repayments are allowed for 5 year fixed loans).
  • Fixed rate loans typically don’t allow for offset accounts to be attached.
  • Just because interest rates are low, doesn’t mean they won’t go any lower. If you choose to fix your mortgage and the Reserve Bank lowers interest rates, then (assuming banks pass on the interest rate reduction) you’ll be paying more than you otherwise would if you stayed variable.

My gut feel is that over the past few years as property prices have shot up, many Gen X & Gen Y have borrowed to their cash flow capacity and haven’t necessarily factored in that average interest rates are closer to 7% rather than 4%. When will interest rates be back around 7%? Who knows. Your guess is as good as mine. But at The Practice – Personal Wealth Advisory when we are developing financial strategies for our clients, we assume that interest rates on home loans and investment property loans are 1.5%-2% higher than at the point of time of developing the strategy. We build in a good buffer to ensure strategies remain appropriate and affordable over the longer term. Think about your own personal circumstances…what would your cash flow look like if mortgage interest rates were 1.5%-2% higher? What would you do if interest rates were this much higher in 2-3 years time? Could you afford for that to happen? It’s important to stress test your own strategy.

You may recall from the very first blog Introduction – Part 1 in this Wealth Creation for Generation X series, that studies have shown that 81% of people spend everything that they earn…and a further 9% of people spend more than they earn (through credit cards and personal loans). These stats are alarming as is…but imagine when interest rates are back to the long term average of around 7%.

For what it’s worth, all our mortgages on my wife’s & my home as well as investment properties are currently fixed – with the exception of a variable loan split on our home which has an offset account attached. Have I always got it right? No way. Around 2 years ago I fixed our home mortgage at 4.99% for 5 years. At the time interest rates were the lowest they had ever been and for a few months it looked like we had reached the bottom. Our kids were 3 years old and 1 year old respectively, and I wanted cash flow certainty, so I happily fixed for 5 years. Then as history has shown, since then interest rates have fallen by around a further 1%…and our home interest rate is still fixed for another 3 years at 4.99%. Have I felt bad about this decision?…not for a second…as I know it was the right decision based on our circumstances at the time. Plus I believe with interest rates, “you win some, you lose some”…2 weeks ago I fixed one of our investment property loans for 4.14% for 5 years. I’ll take that every day of the week….regardless of what interest rates do in the future.

Fixing your mortgage or staying variable is a personal decision…but either way should not be made lightly. One really good option can be to “sit on the fence” and fix half your loan whilst having the other half variable with an offset account attached (to hold your cash buffer whilst saving on interest).

Either way, I believe there has never been a more important time to be actively involved in reviewing your home loan & investment property loan options. Many 2nd tier lenders are aggressively chasing business and offering significant discounts on both fixed and variable loans. Finding a trusted home loan broker can be a valuable and worthwhile step when reviewing your home loan options. My colleague Craig Ridley heads up our outstanding finance broking team at The Practice Finance Solutions and as part of the overall Personal Wealth Advisory team would be delighted to help in not only reviewing your property loan options but also working with you to figure out what is the best course of action in the context of your overall strategy.

Whether you choose to fix, stay variable, or “sit on the fence”…get actively involved in your own financial strategy and make decisions that are right based on your current circumstances…remember that complacency can cost you.

Matthew Morrison is the Director of Wealth Advisory at The Practice, a Personal Wealth Advisory & Business Advisory firm based in Parkville, Melbourne. Matt along with The Practice team are committed to and passionate about developing & implementing wealth creation strategies for clients to enable them to Fuel their Family’s Future (while protecting them along the journey).

Matt and The Practice team can be contacted via http://thepractice.com.au or (03) 8888 4000.

Disclaimer – the above views are general advice only and are purely the opinions of the author. It’s important that you seek personal advice & guidance based on your individual circumstances.

 

 

One thought on “Should you fix your mortgage (now) or stay variable?

  1. Pingback: Wealth Creation for Gen X – What type of super fund is best for you? | Wealth Creation for Generation X

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