Fixed Vs Variable Interest Rate – Fight!

So, about your home loan interest rate. When to fix your interest rate is a question we always get asked by clients, so let’s share our professional response! Firstly, let’s outline what a fixed or variable rate is, and the key factors you’ll need to consider.

A fixed rate?

This is where you freeze the interest rate on your home loan for a given period of time, anywhere from one to five years. Once you lock in the rate, it won’t change during that time. This means that your monthly or fortnightly repayments won’t change over time. And a variable interest rate? A variable interest rate is the opposite – the rate can change depending on the home loan provider. This would then increase or decrease your repayment amounts.

So should I fix my interest rate now?

The answer to this is highly dependent on your personal situation.  To help determine if fixed is for you, here are 2 key factors to consider when deciding if you should fix your rate or not.

  1. 1.Your cashflow (income – expenses).
  2. How the heck does your cashflow relate to your home loan? Surprisingly, it can impact your home loan in a big way! When we consider how clients should best structure their home loan, the first thing we look at is their cashflow.  We need to understand how much you can afford to pay towards your home loan considering your current living costs. We never want to see clients who are struggling to meet their home loan repayment not able to also save money on top of all their expenses.

    Determining what’s left over after your essential expenses (repayments, groceries, petrol, insurance, etc.) as well as your lifestyle expenses (eating out, movies, holidays) can be the golden ticket.  If you work out that there’s not much left over then considering a fixed interest rate may be the safest option.  This is because it will allow you to lock in a set repayment amount for a certain period of time. That way, if there is an interest rate increase  your loan repayment will not change, as a result not impacting your cashflow.

    2.Potential interest rate rises.                                              
  3. Now, we don’t have a crystal ball informing us of interest rate increases, but they’re always something to monitor. Lately we have observed some out of line variable interest rate increases by banks and lenders. This is partly due to their lending costs increasing, and profits being squeezed. However, we also hear talk of the reserve bank (the institution charged with maintaining a healthy economy) possibly under pressure to decrease rates.

    It is also a matter of looking at the offers on the market, and knowing what a good rate is. For example, you might be paying a variable interest rate of 4%, then see a fixed rate of 3.5%. It would indeed be better to lock in the 3.5%, unless you believe the variable rate is likely to drop below the fixed rate in the near future.

A few percent wouldn’t make that much of a difference though… Would it?

To illustrate the potential danger of an interest rate hike on your cashflow, imagine you’ve just scored an awesome rate of 3.65% (variable) for the $600,000 mortgage on your brand new two bedroom, two bathroom townhouse in Richmond. Awesome, only $2,745 a month! That still leaves about $1,000 in savings each month.

6 months later, for whatever reason, your lender has decided 3.65% just won’t do. They’ve decided to change it to 6% instead. That’s fine, your monthly repayments are still only… $3,597 A MONTH?!

All of a sudden you’re only saving $150 each month instead of $1,000, and a week later the transmission on your Toyota Corolla blows, which is going to cost $2,000 to replace.

Maybe we should’ve considered fixed rates after all?

Okay, fixed interest rates are sounding pretty good. Why would I even consider a variable rate?

There are a couple of advantages to variable rates that make them a little more attractive:

  • Usually having a variable home loan will allow you to have multiple offset accounts connected to your loan. We love these because you can use them in the same way you use your bank accounts, while saving you thousands of dollars over the long term. 
  • Having a portion of variable will allow you to repay this loan with extra repayments. We generally work out what you could achieve in 2 years of repaying extra and offset account balances to determine how much you have in variable and how much in fixed.
  • If you were to dramatically increase your income, then the ability to repay the fixed component is restricted (extreme scenario I know, but we try to consider all options).
  • Variable rates don’t always go up, they can go down as well. If yours goes down your repayments will actually decrease. Feeling lucky?

What about a combo deal – fixed and variable interest rates?

Having a combination of fixed and variable interest rates could be a strategy as mentioned earlier to get the best of both worlds.  The key decision to make here is what is how to split the difference? Do you go 50/50? Again this comes back to your overall cashflow each year, any income changes in the future or lump sum gifts/in-heritance coming up.

Wrapping up fixed vs variable rates; as you can tell there are a couple of variances to consider and we cannot emphasize enough the importance of everyone’s unique situation, it’s not a one solution fits all.  Consider the factors like your cashflow and what interest rates are doing and talk to your bank or lender, as we say “when was the last time your bank/lender called you to save some money”.

If you need help structuring your home loan the right way for your situation and to save more money, get in touch.

7Wealth Pty Ltd ABN 44 609 210 246, is an Authorised Representative of AMP Financial Planning Pty Limited ABN 89 051 208 327 Australian Financial Services Licence 232706 and Australian Credit Licence 232706
This blog contains information that is general in nature. It does not take into account the objectives, financial situation or needs of any particular person. You need to consider your financial situation and needs before making any decisions based on this information. If you decide to purchase or vary a financial product, your financial adviser, and other companies within the AMP Group may receive fees and other benefits. The fees will be a dollar amount and/ or a percentage of either the premium you pay or the value of your investment. Please contact us if you want more information.

February 12, 2019