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Is it time to fix your mortgage interest rate?

Is it time to fix your mortgage interest rate?

If you have a mortgage, the current historically low interest rates have no doubt been a welcome relief.

Australia’s official cash rate, as set by the Reserve Bank of Australia, has been sitting at 2.5 percent for the past nine months and economists such as Westpac’s Bill Evans are saying it’s unlikely to go down further. According to Evans, the cash rate has reached its lowest point and will begin rising in the second half of 2015.

So is now the time to fix your mortgage interest rate?

If you would like some certainty in your mortgage repayments, then a fixed interest rate may be for you – it’s easier to budget when you have a fixed rate loan as the repayments won’t change during the fixed period. The problem is that fixed rates have already gone up.

“One year ago, fixed interest rates were below the variable rates,” said Paul Cooke, senior adviser with Parker Financial Services.

“Fixed rates are now all above the current variable rates.”

Nevertheless, you won’t get a better deal on a fixed rate if you hold out any longer.

“Fixed rates won’t go down any further,” Cooke added.

Switching to a fixed rate now means your repayments will initially be higher than if you remain on a variable rate, but you will be in a better position once rates rise in the next 12 months.

“It’s getting to the stage now where it’s worth suffering a little bit of pain now because once rates start to jack up, they will go up fast,” Cooke said.

You can only fix home loan interest rates for a set period – usually a minimum of one year and a maximum of five years. Alternatively, you can hedge your bets by fixing the interest rate on a portion of your mortgage while leaving the remainder on a variable rate.

“I suggest to some of my clients to fix 25 percent or 50 percent of their mortgage,” Cooke said.

“That way if interest rates do stay low, you are getting some advantage of the low variable rate while being prepared for the eventual rise.”

Cooke advised that to get the full benefit of a fixed rate, you should be considering a three-year or five-year term. When interest rates begin to rise as expected in approximately 12 months, you will gain at least two or four years on a better rate.

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Learn more about home loans

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.

How long can you fix a home loan rate for?

Most lenders should let you fix your interest rate for anywhere between one and five years. While rare, a few lenders may offer fixed rate terms for as long as 10 years.

Fixing your home loan interest rate for a longer term can keep your budgeting fairly straightforward, as you shouldn't have to factor in changes to your mortgage repayments if variable rates change, such as when the Reserve Bank of Australia (RBA) changes its rates at its monthly meeting. Additionally, if variable rates rise during your fixed rate term, you can continue to pay the lower fixed rate until the fixed term ends, potentially saving you some money.

Of course, a longer fixed term also means a longer length of time where you may have less flexibility in your home loan repayments. It’s also a longer period where you won’t be able to refinance your mortgage without paying break fees. If variable rates were to fall during this period, you may also be stuck paying a higher fixed rate for a longer period.

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 are the different types of home loan interest rates?

A home loan interest rate is used to calculate how much you’ll pay the lender, usually annually, above the amount you borrow. It’s what the lenders charge you for them lending you money and will impact the total amount you’ll pay over the life of your home loan. 

Having understood what are home loan rates in general, here are the two types you usually have with a home loan:

Fixed rates

These interest rates remain constant for a specific period and are a good option if you’re a first-time buyer or if you’re looking for a fixed monthly repayment. One possible downside of a fixed rate is that it may be higher than a variable rate. Also, you don’t benefit from any lowering of interest rates in the market. On the flip side, if rates go up, your rate won’t change, possibly saving you money.

Variable rates

With variable interest rates, the lender can change them at any time. This change can be based on economic conditions or other reasons. Changes in interest rates could be beneficial if your monthly repayment decreases but can be a problem if it increases. Variable interest rates offer several other benefits often not available with fixed rate home loans like redraw and offset facilities and free extra repayments.