Fixed vs variable interest rates: how to choose in 2022

Interest rates have been on the rise, with more increases predicted to come. Many borrowers may be eager to lock in a fixed interest rate to avoid being slammed with multiple rate rises, but will this really leave them better off?

How high will variable rates rise?

While there’s no way to predict interest rate movements with 100 per cent accuracy, economists from Australia’s biggest banks have tipped that we may expect a cash rate beginning with a ‘2’ in 2023. This may mean that interest rates on home loans could rise between 2-3% over the next two years.

This aligns with what RBA governor, Dr Philip Lowe, said in a recent interview about taking the cash rate to 2.5 per cent; right in the middle of the 2 to 3 per cent target band for inflation:

“How fast we get to 2½ per cent, and indeed whether we get to 2½ per cent, is going to be determined by events. The Reserve Bank Board meets every month. We have at our disposal a huge wealth of data to analyse at each of our meetings when we decide how fast we need to go and how far we need to go.”

It remains to be seen exactly what effect these rate hikes will have on inflation, and what actions the RBA will take in the future based on these effects.  

RateCity analysis based on forecasts from the big banks found that the average owner-occupier paying a variable rate could be paying interest at a rate of 5.14% by 2023. This could translate into an increase of over $600 per month in their mortgage payments.

When will variable interest rates fall again?

It’s important to remember that some of Australia’s big banks are forecasting that the RBA will eventually cut the cash rate, once inflation has been brought back under control.

Commonwealth Bank head of Australian economics, Gareth Aird, said in a June 2022 report that while the RBA looks very intent on dropping the inflation rate quickly with rate hikes of up to 50 basis points, “this will come at the expense of growth in aggregate demand, particularly household consumption.”

“Our expectation is that economic momentum will slow significantly under the weight of a contractionary monetary policy setting in 2023. As such we expect to see policy easing on the agenda in H2 2023. We have pencilled in 50bps of rate cuts in H2 2023.”

AMP economist, Diana Mousina, said in an interview with the ABC that we’re already seeing the economy respond to higher interest rates, and if it responds faster than the RBA expects, then maybe rates don’t need to get to 2.5 per cent.

“But in getting there we will have some economic pain. We think the unemployment rate will increase in 2023. And we actually see the RBA cutting the cash rate again in the second half of next year as inflation slows and you start to see that weakening growth story. And there’ll be room for the RBA to cut hopefully if inflation does slow.”

Keep in mind that even if the RBA does cut the cash rate in late 2023 or in 2024, there’s no guarantee that every bank would pass this rate cut on to its home loan customers straight away. Banks and mortgage lenders may also choose to raise or lower their home loan interest rates out of cycle from the RBA in response to other economic factors.

What do fixed interest rates look like?

Looking at the RateCity database, the average fixed rates for owner occupiers at the end of May 2022 were:

• Fixed 1 year: 3.82 per cent
• Fixed 2 years: 4.40 per cent
• Fixed 3 years: 3.82 per cent
• Fixed 4 years: 5.26 per cent
• Fixed 5 years: 5.32 per cent

So while an average owner occupier on a variable rate could be paying 5.14% interest by 2023, switching to a 4 or 5 year fixed rate could potentially mean paying an even higher rate. And if a cash rate cut does occur in late 2023 or 2024, borrowers on fixed rates may not get to benefit if lenders pass this rate cut on.

If you’re thinking of switching to a fixed rate home loan to avoid interest rate rises, it’s important to compare fixed rate home loan options before taking the plunge, and to make some calculations to estimate if you’re likely to be financially better off.

What’s the best choice for me?

The best choice between a fixed or variable interest rate will depend on your personal financial situation.

For example, if you’re more concerned about keeping your household budget steady and stable, a fixed interest rate could be appealing, as long as you’re confident that you can comfortably afford the repayments. You’d also need to keep in mind that your loan would revert to a variable rate at the end of your fixed term, and the revert rate could be higher than your previous fixed rate. Also, refinancing your home loan during the fixed term could mean paying expensive break fees.

While a variable interest rate would increase the cost of your repayments if rates rise, it’s also possible you could receive a little relief if rates were to fall in the future. Also, variable rate home loans are more likely to offer flexible repayment features, such as extra repayments, a redraw facility, and an offset account, than many fixed rate home loans. These features could offer more options for managing your home loan repayments, even if rates rise. Of course, home loans with more features and benefits also often charge higher interest rates and fees than more basic “no-frills” home loans.

Whether you’re applying for your first home loan or refinancing an existing mortgage, it’s important to compare home loan options before deciding. If you’re not certain whether a fixed or variable interest rate may better suit your needs, you could consider contacting a mortgage broker for more personal advice.

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