What is happening with fixed rates

This post originally published at unohomeloans.com.au

Following the recent election in the US, and the unlikely result, there has been a movement in the US bond markets that has changed the longer term funding outlook for Australian lenders. So much so, that a number of lenders have already increased their fixed interest rates, especially looking out past 3 years. In some cases fixed rates for 5 years went up as much as 60 basis points (or the 0.6 in a 4.6% interest rate). Rates are hard to make sense of so to make this real if you had a $500,000 loan this could mean you are paying $175 more a month and would spend over $19,000 more over a 5 year period.

Fixed rates on mortgages have been at historical lows for the last year, and with a move by a couple of lenders back up we have seen a lot of enquiries about whether to fix and how much.

You can run your own calculation on our highly accurate and flexible refinance calculator.

Whether to fix?

There are really two reasons you might want to fix your rate:

1. You are trying to beat the system (i.e. you are trying to pick when rates will bottom out)
2. You are trying to ensure certainty of at least some if not all of your payments for a reason specific to your situation

We’ll quickly deal with 1.

Trying to beat the banks (in general) in terms of fixing ahead of a movement up in general variable rates is a bit like going to a casino. It feels great if you do ever get it right, but the deck is stacked in their favour. They have better research and insights on their own cost of funding and likely future costs (and their fixed rates reflect this, as we’ll discuss later) and they also control both their variable and fixed rates. If you get it right, it’s great. If not you either lose (pay more than you would have by staying variable) or if you try to refinance early you pay economic costs, basically the difference in interest you would have paid to them.

Fixing to ensure certainty should really be your primary motivation when considering fixing some or all of your mortgage, and as with most things the best option will depend on your situation and what you’re trying to solve for.

Key factors to consider

There are 3 key factors to consider when looking at fixing your loan

1. How sensitive you might be to a rate rise (i.e. could you afford it)
2. How much excess cashflow you have which you could use to pay down your mortgage faster
3. The difference between variable and fixed rates

Sensitivity to rate rises

In the previous decades we have seen mortgage rates well north of 7% so an exercise every person with a mortgage (or considering one) should do is think, “How much would my repayments be if rates went up by 1 or 2% – and how would my lifestyle be impacted?”. The impact could be as ‘little’ as less savings through to cutting out on major spend to major impact on lifestyle through to financial hardship.  When lenders (and advisers like uno) look at your ability to afford the mortgage they tend to use a minimum servicing rate of 7.5% to determine borrowing power. Basically they assume the rate of the loan they are making to you is going to be 7.5% even if it’s not. In theory this means you should be able to afford a rate increase back up to those levels but the reality is we get used to a certain lifestyle based on a certain income that has commitments (such as loan repayments or other expenses) and if those change, making changes elsewhere can be tough.

In short, if through looking at your finances (income, spending, debt, and desire to save) you can see that an increase in rates is going to have a big impact on your lifestyle then considering fixing is a worthwhile exercise.

If your budget is sensitive to interest rate rises, fixing your rate could be more appealing.

What if I have plenty of spare cashflow?

Good for you! .. But in all seriousness, if you have spare cashflow (and no other more expensive debt to deal with first) then applying this to your mortgage can have a huge impact to your bottom line, even over a shorter timeframe like 3 years. Most people tend to know this, making extra payments on your mortgage or using your offset has the double whammy of reducing the balance and reducing the interest because of this.  What you may not know is most fixed products either

1. a) have restrictions on being able to make extra repayments
2. b) don’t offer an offset or only allow you to partially offset, reducing the impact

If you have plenty of spare cashflow and you fix your entire loan and it doesn’t allow extra payments or have a full offset you either reduce or remove completely the greatest lever to paying less over the term of your loan (extra repayments).

The difference between variable and fixed tells a story

For the last year or so the difference between longer-term (5 years) fixed rates and variable rates in the market generally has been pretty small, around 30 basis points (0.3%). Both were hovering around 3.90% give or take 0.3%. This tells the market that lenders expected both short-term (this year) and long-term (5 years) interest rates to remain roughly the same and in this case low. In the last few weeks as lenders left variable rates the same but moved fixed rates back up, especially for 5+ years and by the amount they did it gives the clearest indication that lenders expect rates to go up in the longer term. In some respects this is self-evident. When something (like rates) is cyclical and we’re at historic lows in some respects the only way is up. Short of using this to try and predict where the market will go the difference between variable and fixed (especially if fixed is higher) needs to be factored into how much is your peace of mind worth. Remembering that 4.5% vs 4% for a $500,000 loan equates to $175/month, this might be a lot to pay for peace of mind *if* rates go up.

It’s all about you

When people come to uno they almost universally are solving for ‘getting the best deal’.

Usually, this means some combination of factors (in no particular order) relating to their banking preference, timeline, confidence of decision, peace of mind as well as some financial best deal which could be from their monthly repayment to the total cost over 30 years or anything in between. Choosing whether to fix and how much and for how long requires understanding these priorities and using financial models to help understand how to optimise for what you are solving for.

If you’re concerned, interested, curious or just plain fearful of the recent market changes around fixed rates (or anything for that matter that’s mortgage related) we are here to help.

Author: Vincent Turner is the Founder and CEO of Uno Home Loans