To fix or not to fix?

PRIOR to the Reserve Bank rate cut in early May, demand for fixed rate loans hit a four year high with around 15% of new loans involving a fixed rate.

It's too early to say how the recent rate cut will impact demand for fixed rates, but the current uncertain interest rate environment makes it essential to think carefully before you fix.
  
Fixed rate loans offer several pluses. The payments are set in cement for the nominated term so you don't need to worry about the impact of possible future rate hikes.  If you're on a tight budget where even a small rate rise could see you struggle to meet repayments, fixing can be a sensible option.

In addition, fixed rate loans are becoming more flexible. Some permit up to $10,000 a year in extra payments, and paying a bit more each month is a great way to save on interest costs and pay off the loan sooner.

Adding to their appeal, fixed rate loans have become very competitive over recent months, with some lenders charging below 6.0%. However the Reserve Bank's latest interest rate cut has filtered down to variable loans, and in many cases there isn't much difference between the two options.

Checking out some of the cheapest variable rate mortgages available, Loans.com.au is charging 5.85%, while refinancers can access low rates through the likes of UBank (5.83%) and bankmecu (5.91%). By comparison, you can lock into a one year fixed rate of 5.85% through Homestar, or 5.94% with Greater Building Society.

Fixed loans do have a couple of pitfalls though, and one of these is the possibility of higher fees. That's why it pays to look at a loan's comparison rate - also known as the AAPR or 'true rate'. This includes most upfront and ongoing fees, and provides a better picture of the real cost of a mortgage.

Another downside of fixed rate loans is the potential to be slugged with break charges. These are quite different from exit fees, which have been banned on new loans taken out after 1 July 2011. This ban is designed to make it easier to refinance a variable rate loan if a better deal comes along. Despite the exit fee ban, break costs can still apply to fixed rate loans.

Exactly how much you could pay hinges chiefly on how market rates have moved since you locked in to a fixed rate. If rates have risen, you may not be charged a break cost at all. But if market rates have fallen below your fixed rate, break costs are likely to apply. These are often calculated based on the difference between your rate and market rates, multiplied by both the outstanding loan balance and the years remaining in the fixed term - the final cost can add up to thousands of dollars.

If you're thinking about locking in your home loan interest rate, it can pay to choose a shorter fixed term. The longer the term, the greater the likelihood that market rates will move against you. An alternative is to split your loan between fixed and variable rate portions. This offers the flexibility of a variable rate plus the certainty of a fixed rate.

For more ideas on choosing between fixed and variable rates take a look at my book Making Money.

Paul Clitheroe is a founding director of financial planning firm ipac, chairman of the Australian Government Financial Literacy Board and chief commentator for Money magazine. Visit www.paulsmoney.com.au for more information.

Topics:  fixed interest rates, home loan market, mortgages, opinion, paul clitheroe, rba, variable interest rates



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