Should you choose fixed or variable rates?

With interest rates at historic lows and more talk of further interest rate cuts, many clients are wondering if they should fix their interest rate.

Less flexibility

It is important to note that fixed interest rates have less flexibility than variable rates. That is, if you break a fixed rate loan, you could be up for large penalties. No one really knows how the banks calculate these penalties and after 14 years in business, I have not found any consistency or way of predicting how to calculate them. I believe that the government needs to urgently regulate these fees because it seems no one is keeping the banks honest. Suffice to say, if you fix your interest rate and then subsequently break the fixed rate term, you should expect to pay a significant fee (sometimes tens of thousands of dollars!).

In this regard, if you think you might do any of the below actions, fixing your interest rate might not be the best decision:

  • Sell the property during the fixed rate term
  • Access any equity that accumulates during the fixed rate term
  • Ability to make extra repayments during the fixed rate term (and have the ability to redraw these extra repayments at a later stage); or
  • Ability to actively maximise your borrowing capacity (i.e. have the flexibility to switch to a lender that has a higher borrowing capacity to allow you to implement your financial plans).

History leave clues

The chart below compares the historic variable rate with the current 3 and 5 year fixed rates (assuming the current margin between the current discounted variable rate and the RBA cash rate existed from 1990 through to today – this is important as the higher variable rate discounts being advertised today are really a way for the banks to hand back some of RBA rate cuts that they didn’t pass onto borrowers during the GFC).

Current 3 year fixed rates for investment are around 4.20% p.a. and 5 year fixed rates around 4.55% p.a. If you compare these fixed rates to the historic variable rates, it is difficult to see how you could possibly be materially worse off by fixing today.

Historic variable rate versus current fixed
Click on the above image to enlarge.

Get specific advice

The above analysis is a general advice and commentary only. If you are considering fixing your rate and would like some advice, please contact your Advisor. It is our job to help you with these important decisions.