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Variable or Fixed? Maybe there’s a third option… (and it’s not what you think)

variable or fixedWith constant media chatter about interest rates rising, we’re having lots of discussions with clients about the decision to fix all (or part) of their borrowings. And just like with any other aspect of your mortgage, what’s best for you is going to depend entirely on your personal circumstances.

Below we outline a few things you may not have considered when weighing up the fixed vs variable decision. We also outline a strategy you may not have considered – the “quasi-fix.”

 

So, when are interest rates rising exactly?

Fixed rates have already increased (multiple times) over the last 6-8 months. And whilst there’s been talk of variable interest rates rising for quite some time now, we won’t know when it will happen until it actually does – which we know isn’t particularly helpful!

Following inflation figures released earlier this week, all eyes will be on the RBA when they meet next week (May 3) to see if there will be a change to the cash rate.

For background on why a rate rise is imminent and the mechanisms behind it, read our post here.

Whilst we’d love to have a crystal ball tell us exactly when (and by how much) rates will increase, the fact we’ve had a significant warning helps. Because hopefully you’ve already adjusted your spending habits in anticipation of having to make higher loan repayments soon.

 

Are you worried about interest rates rising and the effect it will have on your monthly cashflow?

Fixed rate loans can be a good option if you want stability with your repayments for budgeting purposes, you have multiple loans and/or investment lending or there are other factors at play.

Fixed rate loans can provide a ‘sleep at night’ factor. i.e. You won’t be laying awake at night worrying about rising rates, because your interest rate (and loan repayment) will remain the same for the 1, 2, 3 or 4 year fixed rate period you have selected.

Right now though, fixed rates are higher than variable rates on offer. The rate differential depends on the fixed rate period, the lender and loan amount, but as at the end of April 22, fixed rates are anywhere from 0.5 – 2% higher than variable rates. So based on the current rates available, you’re essentially paying a premium for the peace of mind that a fixed rate loan brings.

We’re all trying to select the option that will have us paying the least amount of interest. But you won’t know whether you’ve saved interest on a fixed rate loan until AFTER the fixed term has expired. It’s not just about the difference between the variable and fixed rate either, it also depends on the timing of any rate changes.

For example, if you opt for a 2yr fixed rate loan of 3.9%p.a instead of keeping things variable at 2.6%, variable rates would need to rise by more than 1.3% within the 2yrs for you to be better off with the fixed rate. Of course, we’re just looking at this from an interest cost perspective and not taking into account any other pros/cons associated with fixed/variable loans.

But there’s more to it of course … because if variable rates edge above 3.9%p.a when you’re 20mths in to the 24mth fixed rate term, in this scenario, you may still have paid less interest with the variable rate loan, because you have paid a lower rate of interest for a longer period of time.

 

What is the ‘quasi-fix’ strategy?

If you’ve been weighing up the decision to lock in a fixed rate, it’s likely you’ve done some calculations (or had us to do them for you!) to confirm you can actually cover the higher loan repayment.

So why don’t you implement a ‘’quasi-fix strategy,” and commit to making the higher loan repayment now, yourself?

For example, work out what the repayment would be if you chose a 2yr fixed rate (or 3 year fixed rate – or whatever fixed rate period you were considering) and then simply make this repayment amount yourself . Lenders allow you to easily increase your minimum monthly loan repayment online, or you can set up a manual payment into your loan for the difference. It’s simply a matter of making the decision, setting it up and then forgetting about it.

By adopting this “quasi-fix” strategy, you’re making a higher repayment as if the loan was fixed. But since you haven’t actually fixed in the loan, you’re now technically making a repayment that is higher than your minimum monthly repayment (based on current variable vs fixed interest rates). This means you end up paying more off your principal debt with each repayment, rather than just paying additional interest.

If you use an offset account, building up cash in this account has the same effect from an interest-saving perspective as making additional payments into your loan. However, some clients find greater reward/satisfaction in seeing their loan balance reduce. Building up cash in your offset is always a great way to save interest, but for some, temptation to spend it can creep in when you get above a certain level you’re used to having in savings.

The greatest protection against rising interest rates is owing less money, which means the “quasi-fix” strategy can be a good way to help you get ahead.

 

If it’s been a few years since you reviewed your loans, here is your friendly reminder to contact our team. You can get started here, or give us a call on 6286 6501.

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