How do you know if fixed rates are for you?

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Welcome to Finance and Fury

Today we have Jayden with us, and we will be talking about Interest rates. The first Tuesday of every month, the RBA releases the updates on the cash rate.

The markets currently appear to be going down, and the cash rate reflects a negative trend. The markets show that it will gradually reduce from 1.5% to 1.25% in August and in 2020 down to 1%.

Fixed Interest Rates are HUGELY popular right now. And they’re only going to become more popular if interest rates continue to go up.

The question is: How do you know if fixed rates are for you? Or if now is a good time to fix?

Fixed Rate Basics

  1. Fixed interest rates (also known as fixed rate home loans) are interest rates that will not change for a period of time, usually between one to five years.
  2. Variable rates can move up, and down depending on a range of factors – fixed interest rates remain static, giving you certainty on the repayment of your loan.

Why you might Need Fixed Interest Rates

  1. Fixed interest rates are a way to reduce the risk of your loan repayments increasing
  2. During the fixed rate period your repayment cannot change for the period set for
    1. Regardless of the bank, market or RBA interest rate movements.
    2. Great for budgeting future payments

When Fixed Rates might not suit you

  1. The flip side is also true, so if interest rates decrease in the market the lower rate is not passed onto you, but that’s just the start.
  2. Fixed home loans do come with a few limitations when compared to variable home loans.
    1. Australian lenders severely limit how much you can make in additional repayments per year.
    2. If you got paid a large bonus, received a tax refund or wanted to make additional repayments over the set ones – you will have to pay a penalty.
  3. Penalties – break costs: why would you want to break a loan?
    1. Interest rates have come down significantly, sold a property and need to pay back the loan
    2. Break Cost = Loan amount prepaid * (Interest Rate Differential) * Remaining Term.
    3. $500,000 is fixed for 5 years and then is entirely repaid by the customer with 2.5 years
    4. The loan was fixed was 5.50% p.a. - current 2.5-year bank rate 3.50% p.a (2% difference) = $25,000
    5. If you sell the property, you could violate the loan contract and have to pay the break cost
  4. Extra repayments limited
    1. Depending on the bank or lender, it is possible to pay extra on your fixed rate loan.
    2. Amounts – they range from $5-20k p.a. or $30k over the life of the loan
  5. No offset accounts - if you have cash saved up, it won't offset interest

Things to consider

  • Economists sometimes don’t get it right, with certainty they will suggest markets will go up, but in our time we have seen this not to be the case a few times
  • It all depends on international markets

Options for fixing your rates

  1. 1 year fixed rate - don’t like committing for too long a period for all the reasons outlined above
    1. Interest rates could drop over the medium term, you might want to make additional repayments or look at selling your home in the next few years.
    2. The benefit is that you will be able to budget around your loan payments over the next 12 months,
    3. Rates - The fixed rate market is constantly changing and depends on the money and bond market.
      1. Markets think rates will go up, 1 year less than 5 years - RBA indicator – drop of 0.25% 6 months, 0.25% early 2020
      2. If markets think rates will go down, 5 years less than 1 -
    4. 3 and 5 year fixed rates most popular.
      1. Help avoid any volatility in the money markets.
      2. Get more benefit from fixing for 3 years
        1. Similar to variable rates
      3. A 5 year fixed rate will give you the highest amount of certainty of your mortgage repayments.
      4. Banks can be negotiable longer-term fixed rates
        1. Longer-term fixed rates are not suitable for everyone –additional repayments, sell the property or need extra flexibility on your loan like an offset account – it might not be a good idea.
      5. As the market has become more competitive banks have brought their interest rate offers closer to one another.

Other considerations:

  1. The cheapest rate does not mean paying the lowest amount of interest
  2. Application and ongoing fees - Cheap doesn’t always mean good with fixed rates
  3. Larger banks will be a bit cheeky and in a bid to make a little extra money when your fixed rate period expires
  4. Redraw facilities – Similar making extra repayments, some fixed rate lenders will allow you to take out the funds as redraw. A word of warning here, while some lenders will let you make extra repayments – some will consider withdrawing the funds as redraw ‘breaking’ the fixed rate contract, and charge you LARGE fees to access your own funds!
  5. Interest In Advanced– This is a terrific product for property investors and allows you to make bulk tax deductions by pre-paying your interest before 30th June. It can be beneficial from a cash flow and interest rate discount perspective, with some lenders giving you discounts of up to 0.20% off their regular fixed rates.
  6. Split loans - Best of Both Worlds – Diversify risk across portions of the total loan

A quick word of warning

I’ve said it once, and I’ll say it again – a fixed rate isn’t for everyone.

I fixed my rates a few years ago worrying that interest rates were going to shoot up. And they did, for a few months.

Thank you for listening. If you want to get in contact jump onto the contact page here.

Resources:

Resources page – https://financeandfury.com.au/resources/

Bonds and fixed Interest rates – https://financeandfury.com.au/say-what-wednesday-the-skinny-on-bonds-and-fixed-interest/

Property – https://financeandfury.com.au/archive/property/

Interest rates – https://financeandfury.com.au/archive/interest-rates/

Investing in 2019 – https://financeandfury.com.au/archive/investing-in-2019-miniseries/

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