Interest rate wars: How fixing can save you thousands

Interest rate wars How fixing can save you thousands

With the Reserve Bank ready to raise official interest rates any tick of the clock, Jackie Pearson looks at whether it’s still possible to find a good fixed rate home loan deal.

September 25, 2009

At its September meeting the board of the Reserve Bank decided that it was still a little bit early in Australia’s economic recovery to push interest rates up. But make no mistake about it – the cash rate will not stay at its current “emergency” level of 3 percent for much longer.

And the big banks have already shown that they won’t necessarily wait for the nod from the RBA to send their home loan interest rates higher. For several months they have been quietly pushing up their fixed home loan rates in anticipation of an official increase.

So where does that leave you, the borrower? Is it too late to find a competitive fixed rate deal or are you better off riding out any change in variable mortgage rates?

Compare rates
Unless you have a crystal ball it is difficult to know for certain what will happen to interest rates in one, three or five year’s time. Fixing all or part of your home loan can give you the certainty of knowing what your repayments will be regardless of what happens to the cash rate.

For example, let’s take a punt and presume official interest rates will increase by 2 percent over the next two years. Assuming lenders pass on the whole 2 percent increase to their customers, the best variable rate would be 6.79 percent p.a. compared to today’s best rates.

The most expensive variable rate home loan would be up around 8.34 percent and the benchmark variable rate (the average of the big four banks) would be priced at around 7.25 percent.

Those figures make some of the current two and three-year fixed rate deals look comparable. Gateway Credit Union is currently offering 5.99 percent p.a. for two years and MECU’s three-year fixed rate is 6.49 percent p.a.

If you fixed your whole loan – let’s say $250,000 – at 6.49 percent for three years, your monthly repayments would be set at about $1,686. If, on the other hand, you stuck with your variable rate package and rates increased 1 percent after 12 months, and then another 1 percent a year later, after three years you would have paid $3,244 extra with the variable loan.

A bet each way
If you’re worried that rates are going to keep rising for the next few years but still want to benefit from the current low rates for as long as they last, one option may be to split your loan between a fixed and a variable rate.

MECU, Gateway and Reduce all offer the option of splitting your loan between the three-year fixed and variable rates.

Fixing all or a portion of your home loan usually means you will have to accept less flexibility. Additional repayments may not be allowed and many fixed loans don’t come with mortgage offset accounts. Some don’t allow you to make additional lump sum repayments.

And if your crystal ball predictions are wrong and interest rates don’t move in the direction you think you are going to, fixed rate home loans can have a nasty sting in their tail because of break costs.

If you want to get out of a fixed rate deal early because, for example, rates have gone down, the lender will charge you the difference between the interest rate you’ve signed on for and the rate at the time you break the loan multiplied by the loan amount.

Each lender has a slightly different way of calculating break costs so read your contract carefully and do some calculations to make sure you know how much you might be up for.

Fixed rate home loans are generally more expensive compared to current variable rates as you’re paying for the insurance of a steady rate that won’t rise during the fixed period. They can be handy for those on a tight budget but if variable rates drop while you’re locked in to a higher rate, you could miss out on significant savings.

That is why it’s so imperative to compare home loans and read the product disclosure statements (PDS) to make sure the loan is right for you.

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What is the difference between fixed, variable and split rates?

Fixed rate

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

Variable rate

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

Split rates home loans

A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.

What happens to my home loan when interest rates rise?

If you are on a variable rate home loan, every so often your rate will be subject to increases and decreases. Rate changes are determined by your lender, not the Reserve Bank of Australia, however often when the RBA changes the cash rate, a number of banks will follow suit, at least to some extent. You can use RateCity cash rate to check how the latest interest rate change affected your mortgage interest rate.

When your rate rises, you will be required to pay your bank more each month in mortgage repayments. Similarly, if your interest rate is cut, then your monthly repayments will decrease. Your lender will notify you of what your new repayments will be, although you can do the calculations yourself, and compare other home loan rates using our mortgage calculator.

There is no way of conclusively predicting when interest rates will go up or down on home loans so if you prefer a more stable approach consider opting for a fixed rate loan.

What is a fixed home loan?

A fixed rate home loan is a loan where the interest rate is set for a certain amount of time, usually between one and 15 years. The advantage of a fixed rate is that you know exactly how much your repayments will be for the duration of the fixed term. There are some disadvantages to fixing that you need to be aware of. Some products won’t let you make extra repayments, or offer tools such as an offset account to help you reduce your interest, while others will charge a significant break fee if you decide to terminate the loan before the fixed period finishes.

What is a variable home loan?

A variable rate home loan is one where the interest rate can and will change over the course of your loan. The rate is determined by your lender, not the Reserve Bank of Australia, so while the cash rate might go down, your bank may decide not to follow suit, although they do broadly follow market conditions. One of the upsides of variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts.

What is the difference between a fixed rate and variable rate?

A variable rate can fluctuate over the life of a loan as determined by your lender. While the rate is broadly reflective of market conditions, including the Reserve Bank’s cash rate, it is by no means the sole determining factor in your bank’s decision-making process.

A fixed rate is one which is set for a period of time, regardless of market fluctuations. Fixed rates can be as short as one year or as long as 15 years however after this time it will revert to a variable rate, unless you negotiate with your bank to enter into another fixed term agreement

Variable rates is that they are typically more flexible than their fixed rate counterparts which means that a lot of these products will let you make extra repayments and offer features such as offset accounts however fixed rates do offer customers a level of security by knowing exactly how much they need to set aside each month.

What is a split home loan?

A split loan lets you fix a portion of your loan, and leave the remainder on a variable rate so you get a bet each way on fixed and variable rates. A split loan is a good option for someone who wants the peace of mind that regular repayments can provide but still wants to retain some of the additional features variable loans typically provide such as an offset account. Of course, with most things in life, split loans are still a trade-off. If the variable rate goes down, for example, the lower interest rates will only apply to the section that you didn’t fix.

What is a standard variable rate (SVR)?

The standard variable rate (SVR) is the interest rate a lender applies to their standard home loan. It is a variable interest rate which is normally used as a benchmark from which they price their other variable rate home loan products.

A standard variable rate home loan typically includes most, if not all the features the lender has on offer, such as an offset account, but it often comes with a higher interest rate attached than their most ‘basic’ product on offer (usually referred to as their basic variable rate mortgage).

What is a comparison rate?

The comparison rate is a more inclusive way of comparing home loans that factors in not only on the interest rate but also the majority of upfront and ongoing charges that add to the total cost of a home loan.

The rate is calculated using an industry-wide formula based on a $150,000 loan over a 25-year period and includes things like revert rates after an introductory or fixed rate period, application fees and monthly account keeping fees.

In Australia, all lenders are required by law to publish the comparison rate alongside their advertised rate so people can compare products easily.

Who has the best home loan?

Determining who has the ‘best’ home loan really does depend on your own personal circumstances and requirements. It may be tempting to judge a loan merely on the interest rate but there can be added value in the extras on offer, such as offset and redraw facilities, that aren’t available with all low rate loans.

To determine which loan is the best for you, think about whether you would prefer the consistency of a fixed loan or the flexibility and potential benefits of a variable loan. Then determine which features will be necessary throughout the life of your loan. Thirdly, consider how much you are willing to pay in fees for the loan you want. Once you find the perfect combination of these three elements you are on your way to determining the best loan for you. 

What is the best interest rate for a mortgage?

The fastest way to find out what the lowest interest rates on the market are is to use a comparison website.

While a low interest rate is highly preferable, it is not the only factor that will determine whether a particular loan is right for you.

Loans with low interest rates can often include hidden catches, such as high fees or a period of low rates which jumps up after the introductory period has ended.

To work out the best value for money, have a look at a loan’s comparison rate and read the fine print to get across all the fees and charges that you could be theoretically charged over the life of the loan.

How often is your data updated?

We work closely with lenders to get updates as quick as possible, with updates made the same day wherever possible.

Why is it important to get the most up-to-date information?

The mortgage market changes constantly. Every week, new products get launched and existing products get tweaked. Yet many ratings and awards systems rank products annually or biannually.

We update our product data as soon as possible when lenders make changes, so if a bank hikes its interest rates or changes its product, the system will quickly re-evaluate it.

Nobody wants to read a weather forecast that is six months old, and the same is true for home loan comparisons.

What does going guarantor' mean?

Going guarantor means a person offers up the equity in their home as security for your loan. This is a serious commitment which can have major repercussions if the person is not able to make their repayments and defaults on their loan. In this scenario, the bank will legally be able to the guarantor until the debt is settled.

Not everyone can be a guarantor. Lenders will generally only allow immediate family members to act as a guarantor but this can sometimes be stretched to include extended family depending on the circumstances.

What is a valuation and valuation fee?

A valuation is an assessment of what your home is worth, calculated by a professional valuer. A valuation report is typically required whenever a property is bought, sold or refinanced. The valuation fee is paid to cover the cost of preparing a valuation report.