While there is no crystal ball that can predict what will happen to the economy and interest rates in the future, what we can give you is an insight into how to determine whether you would be better or worse off if you fix your loan at a specific point in time.
Variable home loan interest rates
Lenders’ variable home loan interest rates fluctuate approximately in parallel with the Reserve Bank of Australia’s “cash rate”. Variable rates are a reflection of the current economic climate. The Reserve Bank uses the cash rate as a blunt instrument to try to control inflation – when inflation is getting too high (typically when the economy is doing well) the cash rate goes up; when the economy is weakening (inflation usually is lower) the cash rate often comes down.
Fixed home loan interest rates
Fixed home loan interest rates could be termed predictive. That is, lenders look at the cost of holding money at a certain rate for a certain amount of time, and determine the interest rate accordingly.
In general, if a lender expects the cash rate to rise, the fixed rate will usually be higher than the variable rate; on the other hand, if the expectation is for the cash rate to fall, the fixed rate will tend to be lower than the current variable rate.
When a borrower fixes the interest rate on their home loan, they are usually anticipating that the variable rate will rise above the rates which they have locked in.
Lenders may offer fixed terms between 1 and 15 years; however, most fixed rate terms are between one and five years.
Once a borrower has locked in their fixed rate, they will start paying the fixed interest rate straight away.
For example, if a borrower fixed their loan today at a five-year fixed rate which is 2% higher than the variable rate, the borrower would start paying an extra 2% interest right away.
Home loan interest rate scenarios
The graph below shows an example of the first five years of a $300,000 variable rate loan over a 30-year term. The grey, blue and orange lines show the variable interest rate starting at 5.7% while the teal line shows the fixed interest rate at 7.7%. If the borrower considers fixing initially for five years at 7.7% (teal line on graph) and the variable rate doesn’t change from 5.7% during that fixed term (orange line) then, in addition to the borrower’s annoyance at fixing at a higher rate, the borrower would pay $30,000 in extra interest over the five years.
If the variable interest rate rose in a straight line (blue) from 5.7% to 7.7% over the five-year fixed term, the extra interest paid if the borrower had fixed their interest rate would be $15,000.
To break even, the initial interest rate of 5.7% would need to rise along the grey line to reach a rate of 9.7% after five years – in order to pay the same amount of interest as if the loan had been fixed at 7.7% for the same five year period.
This is now the borrower’s decision; are the variable rates likely to reach this rate? If so, for how long will they remain at this rate?
Should you have any questions regarding fixed and variable rate home loans, call 1800 692 765 or email us at firstname.lastname@example.org
This article is for general information purposes only. It has been prepared without considering your objectives, financial situation or needs. You should, before acting on the advice, consider its appropriateness to your circumstances.
About Mortgage Choice
Mortgage Choice is an ASX listed company that seeks to help Australians with all of their financial needs.
Established in 1992, Mortgage Choice was originally established to help Australians improve their financial situation by offering a choice of home loan providers, coupled with the expert advice of a mortgage professional.
Since that time, the company has grown and developed into a fully fledged financial services provider.
Today, Mortgage Choice helps customers source car loans, personal loans, credit cards, commercial loans, asset finance, deposit bonds, and risk and general insurance.
Further, the company offers Australians access to real, relevant and affordable financial advice through our qualified financial advisers.
Mortgage Choice has no balance sheet or funding risk, and consistently delivers strong profits and attractive yields. It listed on the ASX in 2004 (MOC) and is a member of the Mortgage & Finance Association of Australia (MFAA).
Mortgage Choice holds an Australian Credit Licence: no. 382869 and Mortgage Choice Financial Planning Pty Limited holds an Australian Financial Services Licence: no. 422854. Both licences are issued by ASIC.
Visit www.mortgagechoice.com.au or call customer service on 13 77 62.