Fixed Rates
The hot topic this month has been around the recent rise. It has prompted a lot of discussion about fixing versus variable and part variable, part fixed.
There have been a lot of updates posted about the difference of fixed and variable, so rather than do dot points of the differences, I thought I would share some personal experiences and insights of myself and our clients.
Having had the first rise in 12 years, I am very aware a large amount of our clients have never experienced a rate rise. However, before we talk about fixed and variable it is necessary to talk briefly about just how low rates were.
We have been advising clients for a very long time that rates are “abnormally low”, and rates have historically sat higher than they are. As such, clients whom have had mortgages for longer, tend to prepare for these rate rises more, aware of the need to budget for higher repayments.
When rates are low people tend to increase their discretionary spending. We have all been spending more on lifestyle and it is very possible we will need to reduce this proportionally to adjust to the new lending climate. My advice has always been to not spend money you do not have, (personal debt/ credit cards, Afterpay) and always set your actual home loan repayments as if the rates were higher, this way you get used to that feeling of higher rates whilst also growing a buffer in your redraw.
Most clients that have called us in the past few weeks with concerns of rate rises, have a buffer and are already in the habit of paying a little more. The .25% rate rise is about $65 per month or $15 a week on a $500K mortgage over 30 years. If there were 5 rate rises in the next year (1.25%) it would equate to about $330 per month or $77 a week. Encouragingly, most of our home loan clients are already paying more than that in additional repayments.
The big question when the rates rise is inevitably, whether to fix or not? Generally, the time to fix is well before there is a hint of a rate rise. It is essential to know that the banks intend to make money on their fixed rate products. If the fixed rate is set for 3 years today at 4.5% the bank believes this will be profitable for them. Sometimes they get it wrong. I am sure a few banks are losing money on the 1.99% fixed rates of the pandemic, but at the time they were set, it was believed the economy would take longer to recover. We are in more predictable times now, hence the fixed rate being higher than variable, which is usually the case.
Some positives on fixing
Fixing gives the certainty of knowing what your repayments are for the fixed period.
Generally, people fix to have certainty of what their repayment will be. To fix in the current environment you will pay more than variable now, but you will pay more now and possibly less at the end of the term but for the entire term you will be aware of your repayment amounts. There won’t be any stress not knowing how high rates may rise.
This is great for budgeting and great for homeowners who are worried about rate rises. Not all decisions about your loans are financial. Some are emotional decisions and if you feel better knowing what your repayments will be, or the thought of a rate rise would be stressful, then you may consider fixing.
Early this year there were some unheard of fixed rates under 2%, these were lower than the variable at the time and a lot more clients fixed as a result.
Regardless of your decision, always leave a portion of your loan variable, so you can still enjoy the flexibility of extra repayments and offset. Be aware of all the conditions of fixing before you fix. The 70/ 30 split is very popular amongst our clients. 70% fixed for security and 30% variable with offset accounts and no restriction on repayments.
My preference is that clients have a discussion with their broker before fixing even though it is something you can do yourself with the bank. It is always great to have a chat about it beforehand. Fixing is not a decision that can be reversed without cost.
Some downsides to fixing
First and foremost, please know that the most expensive exit fees that exist with home loans are for breaking a fixed loan. Over the years I have had clients experience fixed break fees of up to $63,000. Banks can downplay the possibility of these fees and sometimes they are out of your control. If you get divorced and must sell, the bank will not waive your break fee. If you wish to get a top up in a year for renovations and your bank won’t help you but another bank will, you will still pay the break fee for a fixed loan to move. If you are aware of these conditions and possibilities before fixing, then you will not be surprised if they do pop up. If for example, you were to inherit money and wanted to pay out the loan you would not be able to so without a break fee.
If you do choose to fix, ensure it is a length of time you are comfortable that you will not be making big life changes. Will you be in this home at the end of the fixed period? Will you have a financial change in this time such as having money to pay off the loan or will you possibly be moved for work? These all need to be considered before fixing.
Our phone rang hot with people wishing to fix once the RBA has already increased variable rates, however, the fixed rates increased months before as fixed rates and variable rates move separately.
Many of my clients who have regretted fixing, have fixed in a rising environment, possibly out of fear.
Unfortunately, the banks will capitalise on the fear of a rising rate market. Their goal is to make money, they are a business, and we need to be aware of this.
Close to 80% of clients in my portfolio that have fixed in the past decade have not saved money in doing so. If I have a conversation with those clients, the majority are still happy they fixed, as they knew what they were paying and were able to more effectively budget, this is called reliability of repayments. The WHY of them fixing was to budget effectively and to have stability - not to try and beat the banks at their own game (predicting rates).
Personally, I ride the variable wave while ensuring I set my repayments at least a percent higher than the current rate. During a divorce 6 years ago, I had some investment properties fixed and I lost a substantial amount of money in break fees (nearly $40,000). When I chose to fix rates, it was not to save money but to mitigate the risk across my portfolio. The risk of break fees did not enter my mind as I had no changes planned.
Even the properties I held onto had to be changed to my name and that still incurred a break fee; even when the loan remained with the same bank.
I have clients ask me regularly if the bank will waive the fee if they stay. They did not do this for me (& I am a business partner for them), I assume they are not likely to waive their break fees for anyone.
I am not against fixed loans at all, rather, I am passionate about people being armed with the tools to make an informed decision.
A conversation with a client last week about fixing concluded with them staying variable but the rate we negotiated for them was 7 basis points below their current variable rate. That is nearly 3 rate rises in that variable drop due to negotiation.
Other clients are happy fixing with comfort that paying a little more now will give them confidence in the coming few years.
When you think about the WHY behind the decision to fix and consider both the pros and the possible cons, I think it will help you to make an informed decision.
Some banks have the niche feature of a partial or full offset on fixed loans which blew my mind when I started looking at all banks, rather than just the bank I worked for prior to being a broker. Deciding to fix is also the time to review lenders.
Our brokers are always available to chat to both our existing clients and bank clients who may wish to have a second opinion or who just want to have a chat about the difference in both fixed and variable and between the banks and what they offer.