With official interest rates in Australia tipped to rise later this year and the United States expected to follow suit next year, home buyers and existing mortgage holders are faced with a dilemma. Should I lock in a low fixed rate now or wait?
Economists are forecasting rate rises across the globe, including in Australia, but picking the right time to lock in loan rates is notoriously difficult. No-one knows exactly when, or if, the Reserve Bank of Australia (RBA) will increase the official cash rate.
Rising expectations
Signs of a rebound in Australia’s economy have heightened expectations of higher interest rates at some point in the next 12 to 18 months. The RBA appears content for the moment to hold the cash rate at the record low level of 2.5 per cent, after cutting rates eight times since late 2011 to boost economic activity outside the resources sector.
In March, the new US Federal Reserve chairman, Janet Yellen indicated that the federal funds rate would increase about six months after the government’s asset-buying program ended. The federal funds rate is the interest rate at which institutions lend to each other from funds maintained at the Federal Reserve and are considered a benchmark for other interest rates.
International Monetary Fund executive director Rakesh Mohan echoed her sentiments, forecasting more central banks would lift rates over the next three to five years as global growth improves.
Fixed rates offer greater security
This might seem like a good time to lock in a mortgage at a low rate in expectation of an upturn in the interest rate cycle. Three-year fixed rates offer certainty for borrowers with little capacity to cope with higher repayments. Borrowers will also save money if variable rates edge above fixed rates.
However, the banks are unlikely to offer three-year fixed loans close to current variable mortgage rates when a rise in the cash rate is imminent. They understand the interest rate cycle better than anyone and are unlikely to set fixed rates at a level that will leave them out of pocket.
Lack of flexibility and greater interest payments
There are other drawbacks that make fixing a risky strategy. They are typically substantially higher than variable rates and restrict borrowers from paying off loans early without attracting financial penalties.
This lack of flexibility to make extra repayments squanders the chance to reduce the total interest payments on your loan. Also, fixed rate terms are not long enough to reap substantial rewards given that rates are unlikely to move sharply within the fixed term timeframe. Gone are the days when rates shot to 17 per cent as they did in the 1980s. In contrast, variable rates offer greater flexibility to repay.
Another risk associated with fixing is having a change of heart if interest rates take an unexpected turn. The cost of cancelling a fixed-rate home loan can be thousands of dollars. One way to minimise this risk is to fix part of your home loan, rather than the whole lot.
Fixing has many fans
Despite the drawbacks, recent Australian Bureau of Statistics data revealed a strong appetite for fixed loansi. The figures showed 92,251 fixed home loans were financed in the 12 months to August 2013, up 29,122 on the previous year. The average proportion of borrowers fixing their loans rose from 12 per cent to 16 per cent over the same period.
Yet fixed interest rates can move quickly and unannounced. Ratecityii reported 135 fixed rates have moved up to 0.2 percentage points higher so far this year.
Compare loan rates
Borrowers who currently have fixed-rate loans should compare home loans before their fixed term ends and renegotiate with lenders or switch to a better deal. Now is the time to review your mortgage and shop around before rates inevitably start to rise.
Source: http://www.rba.gov.au/chart-pack/interest-rates.html
Contact Brad Lonergan (Financial Planner) for more information on Home Loans, Mortgages and Financial Planning
0423 621 120 or email at brad@bmkfs.com.au
i. ‘The fixed home loan rort’, finder.com.au, 14 January 2014, viewed 29 March 2014
ii. http://www.ratecity.com.au/media-room/more-reason-to-fix-your-home-loan
