Should you fix your loan?

22nd Jun 2016By: Adrian Sheahan

Should I fix my loan interest rate now?

As a credit advisor, this is probably the most common question I’m asked.

Of course, giving the answer is not as simple as asking the question, and like most problems, the answer will reveal itself after consideration of your individual situation.

Consider why you are looking to fix the rate on your loan

For many borrowers, the decision to fix the rate is all about picking the change in the interest rate cycle. By punting on picking the perfect moment when the fixed rates are at their lowest and variable rates are about to rise, you are hoping to lock in a low rate while the variable rises, thus saving yourself interest costs.

So, what you are actually asking me is, “if I fix my rate now, will it be cheaper than if I stay on a variable rate?”

It’s a fair question and the objective is great, but it’s a tough ask to outsmart the banks when their business relies on getting these things correct. It’s also not the best reason to fix the rate on your loan. The reason you should fix your interest rate is to eliminate the risk of loan repayments increasing as a result of interest rate rises. So the question you should be asking me is; “can I afford to take the risk of interest rates rising and my loan repayments increasing?”

It’s an important distinction because fixing the rate on your loan has wider implications than just locking in your rate and loan repayment amounts for a set period of time.

The pros and cons illustrate just what those implications are;

Pros

  • Certainty of monthly repayments for the term of the fixed-rate period
  • Insurance against rate rises, which will increase your loan repayments
  • The peace of mind that the above two outcomes provide

Cons

  • Additional repayments and lump sum reductions may attract penalties
  • If a loan is paid out during a fixed-rate term, large penalties may be incurred
  • If interest rates fall, you will not receive the benefits of lower interest rates
  • Redraw and Offset accounts are commonly excluded from fixed rate offers

So if you fix the rate just to save interest, you may lose the benefit of your offset account, lose the ability to redraw your advance payments, and you may face hefty penalties if you sell your property and pay the loan out before the fixed rate period expires.

Therefore, even if you have picked the rate cycle perfectly, the interest savings could all be washed away by penalties and your loss of flexibility. Furthermore, if you get it wrong, you will achieve exactly the opposite of what you have set out to do because you will pay more interest than if you had stayed on a variable rate.

On the other hand, let’s assume you and your partner purchased a home three years ago with a substantial loan to finance the purchase. You have decided that now is the time to start a family and your partner is taking extended leave care for the new arrival. The extended leave means that your partner’s income is substantially reduced and the surplus cash you have previously enjoyed, is no longer available. You now face the very real risk that increases in rates and monthly repayments will have a significant impact on the core items of the family budget. Can you afford this, or will it place you under significant financial stress? If the answer is yes, fixing the rate on your home loan may be the tool to eliminate that risk until you’re in a position to reduce your debt or your income rises again.

So when asked “should I fix my rate now”, I will ask the following types of questions;

  • Are you likely to make additional repayments or pay the loan out in the short term?
  • Are you looking to sell your property in the short term?
  • Is there likely to be any change in your income, or that of the household?
  • Are you a risk-averse person who is happy to pay a slightly higher rate to guarantee certainty over the loan repayment?
  • Do you use an offset account or a redraw facility?
  • Although the response to these questions will provide direction, my primary consideration is always, “can you afford the increased loan repayments if rates rise?’

Alternative option

If you are still not sure which path suits you, there is a third option that, under the right circumstances, can provide you with the best of both worlds. Most lenders will allow you to split your loan into separate portions with one having a fixed rate and the other a variable. By having a split loan, if rates rise, you have ensured some level of certainty and protection. But if they fall, you receive some of the benefit from lower loan repayments. By having a variable rate portion, you also maintain a level of flexibility because you can still make additional loan reductions, use redraw etc., on that portion without penalty. Again, this will not suit all borrowers, but it allows you to have your cake and eat it too.

Still not sure if you should fix or not? For some, the lure of potential interest savings will always be the motivation for their decision, but for those who need a little guidance, the best advice I can give is don’t take a punt, but speak with your finance professional or give one of the team at Switzer Home Loans a call on 1300 664 339.

Adrian Sheahan is the manager of lending operations at Switzer Home Loans. Contact him today for a free loan health check.