Mortgages: lock in certainty, or roll the dice on savings?

Mortgages: lock in certainty, or roll the dice on savings?

Over the last few years, interest rates have dropped dramatically. They’re now around a quarter of what they were a decade ago, and half of what they were just a few years ago. The Reserve Bank’s lowering of rates has got some economists and commentators talking; could it be time for a rate rise soon? Or will global conditions mean they have to keep pushing the interest rate down?

Nobody knows exactly when (or even if) the Reserve Bank will raise interest rates again. The good news, however, is that you’ve got a choice that allows you to hedge your bets. Whether you’re establishing a new mortgage or switching from an old provider, you’ve got an opportunity to choose between stability and predictability, and the potential for savings.

Australia’s economy improving
The Aussie economy has been growing slowly but steadily over the last few months. Though some experts are still cautious, others have pointed out that Australia has fared much better than other countries in terms of economic recovery.

Other countries similar to Australia have raised rates. Over the last few years the US has began slowly raising rates. But on the other hand, the European Central Bank has rates hovering around zero. Our Reserve Bank bosses say we’ve got a bit further to go in terms of economic growth before it makes sense to put rates up. But if history tells us anything, they won’t stay this low in the longer term.

Fixed rates = security
One of the main benefits of choosing a fixed rate mortgage is that you’ll have predictability over your repayments for at least the term that the rate is fixed for – usually three years. A fixed rate might be a good choice if you don’t have a lot of wiggle room in your household budget.

The main downsides are that fixed rates are usually locked in at a rate slightly above the current standard variable rate. This helps banks cover themselves in case of an upswing in the interest rate cycle. And depending on the product you choose, you may also be prevented from making extra early repayments without attracting a penalty. You will also generally not have access to offset accounts against a fixed loan.

Despite these downsides, fixed mortgages are still popular. Especially amongst the budget conscious, including first home owners and conservative investors. According to the ABS’s housing finance stats, the percentage of dwellings financed by fixed rate loans has grown slowly over the last yeari.

Variable rates = the potential for savings
Variable rates have the potential to help you save in two ways. First, if official interest rates go down, your provider’s variable rate may go down too. This means lower regular mortgage payments. Second, if you have a windfall or even just a generous salary bump, you’ll be able to make extra repayments to save on total interest, without incurring any penalties. Lower initial payments may also help make those first few years of mortgage repayments a little easier. Alternatively, home buyers may be able to afford to borrow more with a variable rate loan.

However, especially if your mortgage balance is quite high, a sudden jump in your variable rate could mean extra repayments that are tricky to fit in to your budget. Your repayments could vary by several hundred dollars if your interest rate changed by just a few basis points.

Comparing your options
Perhaps you’ve weighed up the pros and cons of fixed and variable rates, and you’re still wondering what you should choose. That’s fair enough – after all, saving money and having a predictable plan are both attractive options. Your decision could depend on a variety of factors, from your household budget to (if you’re investing) the other assets in your portfolio. We’re here to help you get it sorted, so make an appointment today to get on the right mortgage track.

i ABS 5609.0 – Housing Finance, Australia