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This is one of the most commonly asked questions by customers. The truth is that there is no correct answer. No one has a crystal ball... not the banks, not even the prime minister. There are many things that effect the economy (locally and abroad) and the setting of interest rates.
What we do know is that interest rates, despite what the future holds, are currently as good as we've seen in Australia for some 30 years. We also know that interest rates will always fluctuate up and down. What we'd all like to be prepared for is any major fluctuations. If interest rates were to drop dramatically over a specified period, we'd all like to reap those rewards. Similarly, if there were several consecutive rises, it would be ideal to predict that and, perhaps, fix your rate before hand. If only things were that simple!
Let's first look at the pros and cons of fixed and variable rates.
Fixed rates offer certainty. If you were to fix your home loan interest rate at (say) 7.00% for the next five years, a $150,000 home loan (25 year term assumed) would attract monthly repayments of $1,060pm. If you were on a variable interest rate and they were to rise by a total of 2.00% during this period, your loan repayments would increase by $200pm and this could cause substantial financial hardship. In this scenario, there is a benefit in fixing your interest rate.
The pitfalls with fixed rates, other than the obvious annoyance if rates actually drop, is that you generally lose most of those flexible features that a variable rate loan has. Ability to pay extra amounts off your loan to save interest, redraw facility, line of credit, bulk reduction from a sudden cash windfall, etc... these are common features of most variable rate loans.
Arguably, the biggest risk in fixing an interest rate is if you need to break the fixed rate. Let's say you poorly predict what interest rates will do and you wish to take of advantage of a substantial drop in variable rates. Or, let's say you wish to move house due to a change in circumstances. Or, let's say you come in to some money and want to repay or make a bulk reduction to your loan. The lender will almost definitely charge you a fee calculated on an economic loss formula and these fees can amount to several $1000s.
According to the Australian Bureau of Statistics, less than 20% of home loans in Australia are on fixed rates. Rightly or wrongly, this means that an overwhelming majority of Australians prefer variable rate home loans.
Most variable interest rate loans (if not all) allow borrowers to convert their loan to a fixed rate during the term of their loan. Often there is a cost to switch rates, but sometimes it is worth paying (say $200) in order to protect yourself against the potential of substantial interest rate rises.
For peace of mind and the best of both worlds talk to 6-Point about splitting your loan in to a fixed rate and a variable rate portion.
We have assembled a selection of helpful calculators to assist you with the purchase you are borrowing for.
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