To fix or not to fix? What you need to know about your loan interest rate options
Whether you have an existing loan or are looking to take out a new loan, an important consideration is whether or not to fix your loan interest rate. To make the right decision you need to consider your own unique individual circumstances, regardless of the outlook for rates. And to help you make that decision you need to understand the pros and cons of fixed or variable interest rates.
Fixed Rates, the advantages ...
So what are the advantages of fixing the rate. Well mainly it is the certainty it gives you during the fixed rate term. By fixing the rate you fix the repayments. How much of an advantage you get depends on your individual circumstance. If you are on a tight budget, have other loans such has personal or car loans on higher interest rates or a looking to start or expand your family in the near future, fixing the rate may be beneficial. Or you may just want the peace of mind that a fixed rate offers.
... the disadvantages
Fixed rate loans are not as flexible as variable rate loans, and can be expensive if you break the contract during the term. Most banks won’t let you pay extra off the loan during the fixed rate term, or if they do, will limit how much you can, meaning potentially you pay more interest over the term of your loan. You will also miss out on the benefits of any interest rate decreases during your fixed term.
What's the cost of fixing the rate
Given the main reason for fixing the rate is that it eliminates the risk to you that comes with a variable rate, what is the potential cost?
Well for starters when you think about fixing, the main consideration probably should not be to save interest. A fixed rate loan is essentially an insurance policy against financial pressure brought on by loan rate movements. Having said that a fixed rate might save you money, but that assumes rates won’t fall.
At the end of the fixed rate term the interest rate will revert to a variable rate. And this variable rate will likely be the bank or lenders standard variable rate. With so many options and rates to choose from these days that means that you may have missed the opportunity to have a discounted variable rate that could have saved you more over the term of your loan.
Just as importantly during the fixed rate term you don’t have the ability to make extra repayments or change anything significantly on your loan without incurring a cost. These factors alone could potentially save you much more than any benefit from the fixed rate in the long run.
When is the right time to fix?
Your mortgage is a very large financial obligation. For most, it is the largest and most costly financial decision of their life. Careful consideration and regular review are key to getting the most from your mortgage and making sure it works for you, not against you.
Whilst there is never absolutely a right time to fix your loan, it is one aspect to consider at each review milestone you set for yourself. Ideally these should be at least every twelve months for variable rate loans, unless there is a significant financial change, and three months before the expiry of any fixed rate loan.
Splitting the loan
Splitting your loan to be part fixed, part variable can be a valuable approach for some people.
The main reason to consider splitting is that you can have some of the flexibility that a variable rate brings whilst, in part, having the stability and financial security that a fixed rate brings. Having part variable means that if you are a good saver you can still take advantage of the benefits that access to offset facilities and redraws offer.
Splitting can be wise if you have a higher disposable income at some stage during the fixed rate term, but there is a likelihood that your income situation may change. An example would be family or job changes resulting in significant temporary income changes.
The bottom line
Regardless of whether you choose a fixed rate mortgage or not, how you arrange your loan and the features you choose will have a significant impact on your finances and your life.
You should remain mindful of the limitations of fixed rate loans including the inability to apply to extra payments and redraw. Remember, just like the chance that rates will rise, there is a chance they will fall as well. And be cautious of what your friends, family or work colleagues think is best. Whilst they will likely have the right intentions, what’s best for them and their situation is unlikely to be what’s right for you.
Make sure you understand why you have the loan that you do, whether the features and benefits really match your needs, and then get it at the best possible price you can.
If you are unsure then professional advice from an experienced finance professional, like FNQ Finance Guy, can assist in making the right decision.
Whatever you do own the decision, after all, it’s your money.