Fixed, variable or split – finding the right fit for you
In Australia, there are a number of ways to structure your home loan repayments. Finding the best option may save you time and money on your mortgage. Here is some information to help you choose the repayment structure that works best for you.
The major reason why most people fix should not exclusively relate to trying to beat the market. It is possible, however, it is hard to do. It really should relate to the desire to have budgetary certainty (i.e. it is a risk management play) or to put one’s finances on autopilot (you know you are not going to have head space to review rates and/or you won’t be in a strong financial position to switch lenders) so you fix.
Given that we have been in record lows for interest rates the last couple of years, it has not been a bad bird to hold in hand with respect to fixed rate pricing. Many Naritas clients had the fortune of fixing in their interest rate at 3.59-3.69%p.a. for 2 years just under 2 years ago – that price has consistently been ahead of the market. Naturally, depending on your requirements your mileage may vary.
Jump to section:
- Why choose a variable rate loan?
- Why choose a fixed rate loan?
- Why choose a split rate loan?
- How do I beat the variable interest rate market?
- Would you like some help structuring a mortgage?
Variable interest rate loans are all about flexibility. Essentially, with a variable rate loan, the interest rate moves up or down as the market moves. This means your loan repayments may also change month-to-month.
If the interest rate drops, then your repayments may drop as well. However, in the event of an interest rate rise, your repayments could also increase.
Many variable rate loans come with additional features, which can reduce the amount of interest paid over the life of the loan. For example, a variable rate loan with a 100% offset arrangement links your loan account to your savings account. Any funds held in your savings account are offset against the borrowed amount, reducing the interest you have to pay.
Many variable rate loans offer flexibility in terms of increased payments, allowing you to pay off your loan faster if you have additional funds available.
A fixed rate loan is one where the interest rate is fixed for a limited period, and immune from any movements in the market. The most popular choices are three and five-year fixed interest loans, although options ranging from one to ten years are available.
Fixed rate loans allow you to make steady, regular repayments. They’re great for borrowers on strict budgets, or if you’re entering into a mortgage at a time when interest rates are likely to rise.
In the event of a drop in interest rates, being locked into a fixed rate may mean your repayments are higher than they otherwise would be. It’s also worth noting that breaking a fixed rate loan can potentially cost thousands of dollars in fees.
Additionally, many banks will charge you a fee for making extra payments towards the loan during the period it has been fixed.
A split rate loan is when you break your mortgage into two loans – one with a fixed rate and one with a variable rate.
It’s something of an ‘each-way bet’. A split loan offers borrowers protection from rate rises (with the fixed portion of the loan) alongside the advantage of rate drops (with the variable portion of the loan).
Most banks will allow you to split your loans from the outset, without having to pay for two separate loan applications.
If you are primarily interested in fixed rates as way to beat movements in the variable rate market, the major factors to consider when analysing variable delivery rates to consumers are as follows:
Reasons for increase:
- Australia’s Credit rating – If it is downgraded the cost of wholesale funding is likely to increase.
- The US Federal Reserve (The Fed) raising interest rate rises in the USA – Any movements made by The Fed will likely proliferate costs in bond markets (market accurately picked this recently and we saw fixed mortgage prices adjust ahead of the recent Fed announcement).
- BASEL and APRA requirements driving up costs of compliance and overheads – Depending on level of market competition these costs may be pushed to consumers.
- RBA adjusts cash rate upwards to slow lending growth to abate any concerns to do with Sydney and Melbourne property markets – The cash rate is a major component of variable mortgage delivery rates.
- Defaults increase – Investors demand higher returns in exchange for perceived risk to do with funding residential mortgage-backed securities (RMBS).
Reasons for decrease:
- RBA adjusts cash rate downwards to stimulate economic growth amid concerns of recessionary fears for areas outside of Sydney/Melbourne – The cash rate is a major component of variable mortgage delivery rates.
- Competition between lenders increases causing them to cut margins to win business. This has already been happening – Lenders have indicated a desire to increase margins – so realistically there will need to be some strong competition to overcome that desire for lenders to increase returns to investors.
- Regulatory overheads are scaled back – APRA decides to remove speed limits on investment lending growth or legislation/regulators dilutes NCCP Act compliance overheads, the flow-on being that profitability of loans increases. Lenders may choose to pass these savings on to consumers depending on levels of competition.
- RMBS pricing drops dramatically – This may occur due to reasons such as the US Fed feeling their economy is tanking or other classes of assets are seen as relatively high risk in comparison RMBS.
- Savers are willing to accept lower returns on savings because of the relative risk of other asset classes – Don’t laugh! Interest rates have gone to zero in other countries in recent years. Low interest rates paid to savers = the potential to offer low rates to borrowers for lenders who fund their mortgages using customer savings (which are typically ADIs).
Depending on how you weight the major factors listed above you should be able to come up with an answer on which way you feel rates are headed. In short, the pundits who are supremely confident on picking these movements are some of the highest paid people in the finance world and are not likely to share their insights altruistically. Looking at ASX 30 Day Interbank Cash Rate Futures may be the closest you can get to a free window into where big money is picking the cash rate (which is an influencer of variable rates) to go in the near future.
Choosing the right kind of loan depends on your personal situation, earning capacity and long-term goals for your property. Speaking with a credit adviser may help you to figure out the best way forward, and could help you save money along the way.
The team at Naritas are experts in delivering timely guidance & finance approvals. We have over 100 lenders on our panel & a high quality team of dedicated credit advisers to steer you efficiently through the approval process.