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There’s been a lot of press about fixed interest rates recently, and I received this email from Katrina Gay, Financial Planner extraordinaire. It’s a fantastic analysis of fixed versus variable interest rates:
Katrina says:
“I have started to received quite a few queries from clients about whether to fix their interest rates. There is no doubt that interest rates will go up in future, but this doesn't necessarily mean you will be better off fixing your rates.
1. Prediction
As many of my clients have Westpac professional package loans, I have used the current Westpac fixed rates in the examples below.
The current Westpac three year fixed professional pack rate is 6.79% pa. If you were to try and beat the variable rate by fixing now at this rate, you would have to believe that the average interest rate over the course of the three year period is likely to be higher than 6.79%. If, for example sake, we use a steady, straight line interest rate increase, then to break even with fixing at this rate, you would have to see discounted variable rates rise from 5.11% (current) as follows:
to 6.21% by Aug 2010
to 7.31% by Aug 2011
to 8.41% by Aug 2012
So in order to profit from fixing your rate for three years, you would need rates to rise by an average of 5 lots of 0.25% each year over that time.
Using the current Westpac five year fixed professional pack rate of 7.44% pa, and steady, straight line interest rate increases, then to break even with fixing at this rate, you would have to see discounted variable rates rise from 5.11% (current) as follows:
to 6.06% by Aug 2010
to 7.01% by Aug 2011
to 7.96% by Aug 2012
to 8.91% by Aug 2013
to 9.86% by Aug 2013
So in order to profit from fixing your rate for five years, you would need rates to rise by an average of 4 lots of 0.25% each year over that time.
If you think that it is highly probable that rates will be higher than the figures above at those points in time, then you have a good argument for fixing. But, as with the share market, nothing is certain, so I personally prefer to keep all my loans variable. Looking historically, it is more common for people to lose rather than win by fixing their rates.
2. Cashflow
I don't believe prediction is a good reason for choosing to fix your loans. However certainty of cashflow IS a good reason to consider fixing. If you have a tight cashflow position, and/or a small liquid buffer, then fixing is a good idea to have certainty over future payments. By fixing you are often paying a premium in order to have this certainty.
3. Other considerations
Keep in mind the following disadvantages of fixing your loans.
• Most fixed loans restrict the amount of additional repayments that can be made during the fixed period
• Most fixed loans will not allow an offset account to be linked to the loan
• If you sell the property then break costs may apply
• If you want to access increased equity in the property, you may be either tied to using the current bank (which means accepting their valuation), or have to pay break costs to move banks
• If the economic recovery stalls or suffers a further setback, then we could see interest rates remain low for some time
Other banks
Medine regularly updates her fixed rate table for all the big banks. Her latest update shows that Homeside, ANZ and St George's fixed rates are all slightly higher than Westpac's.
RAMS have a special offer on where you can fix half of your loan for three years at 4.99% (the other half must stay variable and the current rate is 5.49%). However there is a deferred establishment fee of 1% of the loan balance to exit the loan within 3 years (on top of any break costs), the loan can only be interest only for 2 years (it then reverts to P&I), and the set up costs are $845. So on the surface the RAMS offer looks quite good, but there are a lot of restrictions.”
I hope there’s some good food for thought there for you. Please don’t hesitate to contact me if you have any queries at all.