One of the questions most asked of a mortgage broker by clients is whether they should fix their loan or not. This is a tricky one as it involves speculating on if we believe interest rates will go up or down in the future. Under the rules of the National Consumer Credit Protection Act, to which all brokers must adhere, we cannot speculate on your behalf and so are not able to advise you to fix your loan or to go with a variable product.
We can, however, tell you the pros and cons of both fixed loans and variable loans and let you know that you may also have a bit of both.
This type of loan is generally more flexible than its fixed counterpart. It is usual that you can make unlimited extra payments on the variable loan to help pay the loan off quicker and, depending on the loan itself, you may be able to avail yourself of an offset account to further assist in reducing your debt. Historically, variable rates tended to go up when the RBA increased rates and go down when the RBA lowered rates. These days, this is not always the case however in a general sense the rates will somewhat follow the RBA movements still. On the up side, if your bank drops their variable rates you will be able to take advantage of lowered rates and therefore lower repayments. On the down side, if your bank increases variable rates, your payments will go up.
It is important to note that banks are not bound by the RBA – they can increase or decrease their variable rates at any time and for any amount and it has become more commonplace for banks not to pass on full rate cuts – although this may change in the future.
This type of loan provides more certainty if not as much flexibility. The rate is set by the bank for the number of years on offer. So, you can have a set rate that lasts for 1, 2, 3, 4, 5 or more years. Some lenders allow you to pay extra money into your fixed loan however it is normal for this to be a limited amount, although there are exceptions. Offset accounts are not typically available for a fixed loan account either however there are exceptions to this rule also and it is available in some instances.
The main concern with a fixed loan is what lenders refer to as their economic loss. When you take out a fixed loan, you essentially promise the bank that you will make set payments over a set number of years. If you choose to pay out the loan before the end of the fixed term, if you sold your home or wanted to refinance your loan etc, then the bank would work out what money they have lost – because they will no longer be receiving your payments – and charge you accordingly. There is no way of knowing what the bank’s economic loss would be until the time comes as it is calculated based on current cash rates, among other things, and changes on a daily basis.
So, it is wise to be sure that you are happy to remain in the loan for the fixed period at least. On the plus side, you know exactly what your payments are and can budget accordingly. If variable rates rise this will not affect your loan. On the down side, if variable rates drop, you will not be taking advantage of any possibly lower rates.
You can also hedge your bets and have some of your loan fixed and some variable if you choose to gain some of the advantages while minimising some of the disadvantages of each product.
There are also other quirks of fixed loans. Want more information? Give our experts at Carbon Finance a call – we are specialists in loan structure and will help you decide what the best options are for your unique needs.