For many property investors, the decision to fix or not to fix a home loan can be difficult. For some, staying on top of their mortgage repayments is enough to motivate them into fixing their rate for peace of mind.
Others may choose not to take out a fixed interest rate because they have plans to sell the property soon, or they have a substantial amount of cash to offset their loan.
In this guide, we’ll explore what you need to know about your situation before deciding whether or not you should get a fixed home loan.
1) What is a Fixed Home Loan?
A fixed home loan is when the interest rate and monthly repayment on your mortgage remain the same for a certain period, irrespective of the rates increase or decrease.
This is opposed to a variable rate home loan, where the interest rate may increase or decrease over time. As a result, the amount you pay will fluctuate if or when this happens.
2) Why Do Fixed Rate Home Loans Offer Stability?
Generally, banks offer fixed rates for a particular period of time: one year, three years, or five years. Some lenders allow even longer.
This provides you with the ability to plan and budget for the future. No matter what happens during your fixed home loan term, you know exactly what is expected of you month in and month out. There are no surprise costs or fluctuations regarding your loan to keep extra savings for.
3) What Are the Disadvantages of Fixed Rate Home Loans?
Knowing that you have a set amount to pay monthly can be reassuring when times are tough.
It may sound like an oxymoron, but the problem arises when things are going great.
If your income grows and you want to make extra repayments on your home loan, a fixed home loan won’t allow this.
For the duration of your fixed home loan, you may not pay a cent more or a cent less towards your mortgage than what is required of you. This means that you cannot pay your home loan off any sooner during the time it is fixed.
Realistically, you could if you really wanted to. But then you’d have to deal with the high break costs.
4) Should I Fix My Home Loan If I Want to Break It Early?
A question alongside “should I fix my home loan” should be “can I commit to a fixed home loan?”
If you break the fixed period, you will be charged exorbitant fees.
Banks usually borrow money from wholesale money markets when you fix your loan. They do this through the Bank Bill Swap Rate (BBSR). They use this third party to lock their funding costs at a fixed rate.
If you decide to change the terms of your fixed loan prematurely, your bank subsequently suffers a loss. Australian law dictates that you are responsible for compensating your lender for their loss as it was a direct result of you.
This is also true if you decide to sell the house during your fixed term period.
These things result in break costs.
5) What Are Break Costs?
Your bank will owe money on the BBSR if you end your fixed loan term with them early. This outstanding balance is passed on to you, and this is called break costs or exit fees.
The longer you still have to go on your fixed loan term, the more the break costs will be.
Generally, the break costs are calculated by multiplying the total loan amount by both the remaining fixed term and how much the interest rate has changed.
Loan amount x (remaining years) x (difference in interest rate) = break costs
Your home loan is $600,000 with a fixed rate of 5%. Your term runs for five years. After the third year, you want to refinance your loan and have to break your fixed rate contract to do so. By this point, the interest rate has increased to 5.5%, meaning that there is now a 0.5% difference.
$600,000 x 2 x 0.5% = $6,000
Your break costs are therefore $6,000 ( please only use this as an example)
This is only one example of how banks might calculate break costs. As you can see, you need to weigh up the pros and cons before deciding to break your fixed rate home loan agreement prematurely.
6) Should I Fix My Home Loan If I Want a Redraw Facility and Offset Account?
Fixed rate loans generally don’t boast the features that variable rate loans do.
If you want to use these features on your fixed loan, only a selected couple of lenders have such product to do so, however majority of the lenders do not hold this feature with a fixed rate.
- If you would like to make extra payments to your home loan to reduce your overall balance, a redraw facility is a great option.
- Although you do have access to that surplus money should you wish to redraw it, like for home renovations, you have to apply to redraw it, but generally you would not be able to redraw the money out until the fixed rate expires, also if you pay more into the loan then what the bank allows in a fixed rate, you will incur a breakcost.
- This is a separate account linked to your home loan that you can pay money into and use as savings.
- Unlike the redraw facility, you can use this as an everyday account as the money is easily accessible.
- Remember, only a couple of banks allows for offset on a fixed rate, majority does not have offset against a fixed rate.
These two features are uncommon with fixed rate home loans because both influence the interest rate of the loan. This is problematic because a fixed rate leaves no room for fluctuations.
With a variable rate home loan, extra repayments within your redraw facility reduce your loan balance. Your interest is worked out according to how much money you owe – so a smaller balance means a smaller interest.
Similarly, the money present in offset accounts is offset against the balance owing on your home loan. So you only pay interest on the difference. The more money in your offset account, the smaller the difference will be between the two, and subsequently, the smaller the interest will be.
If you’re wondering, “should I fix my home loan” when current interest rates are low, choosing a fixed rate home loan can preserve those interest rates for years to come.
But, don’t sign up for a long-term fixed rate loan if you might have to break it in the future. The costs may not be worth it.
Consider the features that variable rate home loans offer that fixed rate home loans don’t – do you require redraw facilities or an offset account?
Every person has their own unique situation. Chat to one of our mortgage brokers today, and they can offer advice personally tailored to you and your financial goals.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.