Wondering whether to choose a variable or fixed interest rate? Adelaide mortgage broker Hayley Walsh helps you weigh it up.
The two buzzwords on everyone’s lips in Adelaide and across South Australia at the moment are inflation and interest rates.
If you belong in the 37% of Australian households that owns a home with a mortgage, there’s a good chance that interest rates are commanding the lion’s share of your attention.
And if you’re trying to break into the property market and buy your first home, you’re likely to be paying even more attention to the Reserve Bank of Australia’s recent actions.
The cash rate had risen from its record low of 0.1% in early May to 1.35% in July with the expectation it will hit 2.6% by early next year.
It’s 12 years since borrowers have faced back-to-back rate increases.
A rise of just half a percent, like the one in June, means that anyone with a $500,000 mortgage will be paying an extra $130 a month or $1600 per annum.
It leaves homeowners to tackle the age old question: whether to go with the flow and ride the variable rate skyward or lock in a fixed rate while you can.
The answer may just surprise you.
Before we compare variable and fixed rates, let’s first put the sudden rise of interest rates in perspective.
Australian borrowers have had it ridiculously good for nearly a decade.
By the end of the decadent 1980s, the standard variable home loan interest rate in Australia had soared to a record 17%.
It hit that peak in June 1989 and remained there until April 1990.
It’s true homes and mortgages were not as expensive then and that mortgage payments consumed a smaller amount of people’s average wages.
But it still claimed its casualties in terms of foreclosures.
Rates didn’t fall below 10% until July 1996. They have been at 6% or lower since March 2013.
So while circumstances may be challenging, it could be much worse.
👍 – Protected from interest rate rises
👍 – More certainty makes it easier to budget
👎 – Often paying higher than variable rate
👎 – Can’t repay loan quicker
👎 – Hefty exit fees
👎 – Won’t benefit if rates fall.
So let’s break it down.
Fixed rates offer certainty.
By locking in your payments for a period of time, you protect yourself from rate rises and can budget more easily.
Fixed terms are generally offered between one and five years – sometimes up to 10.
In an environment where rates are rising, fixed loans can look quite attractive.
The downside is that they normally allow for only very limited additional repayments, hence paying off that loan quicker is not possible.
And they attract hefty exit fees, sometimes up to $15,000, if the borrower wants to exit the loan.
Fixed rates exploded at the start of the pandemic, soaring from 15% to 50% of loans, as banks and borrowers both tried to protect themselves from an uncertain future.
With the variable rate at rock bottom, there were some very attractive fixed rates on offer.
But in a climate of rising interest rates, that no longer holds true.
Following the Reserve Bank’s 0.5% interest rate rise in July, 2022, the Commonwealth Bank lifted its standard variable rate to 5.8%.
But the five-year fixed loan rate was 6.84%.
That’s because in a climate of rising interest rates, banks factor in the likelihood of future rate rises into their fixed rates.
👍 – Flexibility to pay off loan quicker
👍 – Ability to refinance elsewhere
👍 – Option to utilise line of credit
👍 – Benefit if rates fall
👎 – More uncertainty makes it harder to budget
👎 – You’ll pay more if rates rise
Variable rates fluctuate in concert with the Reserve Bank’s cash rate.
Rising inflation is usually met with rising interest rates as the Reserve Bank attempts to tighten spending and take the heat out of the economy.
They offer greater flexibility in terms of increasing mortgage payments and can be accompanied by a line of credit which is both convenient and allows every dollar earned to come straight off your loan.
If you have a variable rate, it’s much easier to move to a better deal elsewhere, without attracting exorbitant exit fees.
And if rates actually fall, you’ll be much better off than on a fixed loan.
Equally, if rates rise, you’ll have to find more money to service your mortgage.
Using the CBA’s July 2022 rates as a guide, the variable rate would have to rise beyond 7.88% over five years for borrowers to be better off on the fixed rate of 6.84%, rather than the standard variable rate of 5.8%.
And borrowers with a good loan-to-value ratio (LVR) will be offered a significantly better deal than the standard variable rate.
Anyone who can take advantage of a popular rate of 3.39% for those with an LVR of between 70-80%, will be better off avoiding fixed rates unless the variable rate heads north of 10%.
Making the call
The decision to opt for fixed or variable rates is basically a gamble.
It’s a gaze into the crystal ball as to whether rates are likely to rise or fall over the term of the fixed loan.
You can assess what banks think will happen by how much more expensive the fixed rate is than the variable rate.
But as we’ve already discussed, it’s not just the interest rate or size of your repayments that you should be considering – you also need to factor in the raft of restrictions that accompany having a fixed rate.
There were some savvy home owners who locked in some very good fixed rates before they started to climb.
That was the time to do it and that time has now passed.
Economic conditions can change without warning and it is possible fixed loans may again be attractive.
But for the majority of borrowers not already on a fixed loan, the variable rate is likely to be the best option.
Get advice today
If you are worried about rising interest rates and considering refinancing, or about to enter the market for the first time, it’s imperative to seek out quality advice.
While variable rates are currently recommended for the majority of borrowers, everyone’s circumstances are different and your personal ones should be considered.
Calder Finance Broking are specialists in property finance in Adelaide and across South Australia.
We can advise you on the most prudent strategies for your situation and help you find the very best loan deal on the market.
It may even be possible to hedge your bets and opt for a split rate offering part variable and part fixed components.
The information contained in this article is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a financial adviser.
Taxation, legal and other matters referred to on this website are of a general nature only and are based on Calder Wealth Management’s interpretation of laws existing at the time and should not be relied upon in place of appropriate professional advice. Those laws may change from time to time.
Calder specialises in wealth management with a focus on advice, investment, sustainability, insurance and finance.
Written by Hayley Walsh from Calder Finance Broking, for more information please visit the Calder Finance website. Please note that Calder Finance Broking Pty Ltd is a Corporate Credit Representative of BLSSA Pty Ltd ABN 69 117 651 760 ACL 391237.