Stable interest rate period begs the question – opt for fixed or variable?

Posted by | March 16, 2014 | Employers, General, Job Seekers, Recruiters, Update

Information brought to you by Jobs In The Hunter specialist partner, Finance On The Coast …

Ask an economist where interest rates will be in two or three years and the likely answer will be that no one can see that far into the future when it comes to an economy’s ebbs and flows.

But an astute economist can probably tell you that what goes up must come down, and vice versa. Interest rates, like the broader economy, move in cycles.

But, in case you thought that makes a decision to borrow on fixed or variable rates easier, there is no way to know how long and high or low the cycles will be.

Remember, interest rates in Australia are at historic lows at the moment.

Aside from hedging your bets against the fluctuations, there are sound structural reasons why one form of borrowing might be better that another.

Variable rates have several structural advantages, especially in a stable rate environment and when an economy is growing and jobs are secure [see chart below].

But there are horror tales from the 1980s, for example, of people who borrowed on variable rates to buy homes in the good times only to have interest rates in some cases more than double and, because of a contracting economy, to loose their equity in their home.

More borrowers are now choosing to fix their loans, says Phil Riches, Senior Mortgage Consultant for Finance on the Coast

“Statistics show the average proportion of borrowers fixing their loans is more than 16 per cent of the overall market, compared with 12% for year ago,” he said.

“So, with fixed rate terms of one, two or three years lower than discounted variable rates at this point in time, they can be appealing.

“Key considerations for borrowers should be confirming the indicated variable rate once the fixed loan expires, ensuring the loan is not fixed for a term beyond when the loan will be paid out, and whether it is possible to retain some flexibility such as a fully offset account and/or ability to make extra repayments during the fixed term.

“At Finance on the Coast, we see an increased interest in fixed rate loan inquiries. We go over the typical benefits and disadvantages of variable and fixed rate loans and where our clients indicate a desire to fix their loan.

“Where suitable we finance them with a lender who allows fixed rate loans with 100 per cent offset and no ongoing fees,” he said.

One advantage of a variable rate loan is, as personal prosperity grows and the family income gets bigger, the loan can be paid down quicker, without penalty.

Fixed rates give some certainty. You know what the repayments will be for the duration of the loan.

If you borrow at 5 per cent and, over time, rates go to 7 per cent, you are clearly in front.

But it’s because of the uncertainties of the financial cycle that banks or other lender will give you a fixed rate for a specified period, sometimes up to 10 years.

If, in five or 10 years, rates are high and your loan is switched to a variable rate because the fixed rate period expires, it can be a steep lift in repayments.

Loans and the circumstances in which they are made are as individual as the borrowers.

That’s why it is key to get specific advice based on individual circumstances.

Even within the fixed and variable loan rates there are differences – such as a cocktail of fixed and variable – that enable a tailoring of the loan for the optimum result for the borrower.

JobsOnTheCoast/JobsInTheHunter founder Tim O’Brien says there is no longer such a thing as a job for life.

“It is normal for someone’s career to change direction much more than once and it’s difficult to predict what is around the corner.

“This may include different jobs with different levels of income, or perhaps setting up an business.

“So it’s important to not only set out on the right track but also to get the right advice as your situation changes over time.

“Phil and his team at Finance On The Coast not only have access to a vast array of lenders and mortgage types, they also have the necessary experience to look at individual circumstances and find solutions to non-standard requirements,” Mr O’Brien said.

For further information or enquiries contact Phil Riches, Senior Mortgage Consultant for Finance on the Coast, on 0418 204 304 or email phil@financeonthecoast.com.au

Variable rate loans:

For

  • Flexibility to make extra payments without penalty
  • Opportunity to redraw from equity in the loan
  • No penalty for early discharge or refinancing with another institution (administration fees do apply)
  • Interest usually moves down when the Reserve Bank cuts its rate.
  • Linked off-set accounts are available with most variable loans. (These charge interest on the amount of a loan outstanding minus any plus balances on the off-set account)
  • Flexibility to increase the amount borrowed (to put in that swimming pool, for example)

Against

  • When the Reserve Bank lifts its cash rates, repayment rates go up accordingly. To illustrate, loan repayments on $500,000  of principal and interest basis over 30 years  at today’s discounted variable rate of about 4.99% are $2,682 a month. The same loan at 20% interest is $8,356 a month
  • Restriction on borrowing limit based on what you can repay and a margin against interest rate rises, usually a factor of 1.5 to 2 per cent

Fixed rate loans:

For

  • Certainty of ongoing repayment during the fixed term
  • Protection from increased interest rates
  • Option to fix for up to 10 years
  • Peace of mind and ability to set a household budget accordingly
  • Ability to ‘lock in’ todays fixed rate at time of application (most lenders charge a fee for this)
  • With some lenders, ability to increase amount you are able to borrow when taking a 5-year fixed rate

Against

  • Depending upon what rate you fix at, what happens to variable rates and how long until the fixed rate expires, there may be a fixed rate break cost on exiting the loan if you need to discharge during the fixed term because of the sale of the property or refinance to another lender (not to be confused with exit penalties, which have been abolished)
  • Limited extra repayments, usually restricted
  • Offset account not offered with fixed rate loans (there is one lender who allows a 100 per cent offset on a fixed rate loan)
  • Mostly fixed rates not offered when taking a construction loan to build a new home
  • No ability to increase or decrease the loan limit during the fixed term

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