What a great question! We’re glad you asked. Like many things, timing is everything when it comes to securing finance. The past couple of months have seen more significant pressure on interest rates, with fixed rates so far bearing the brunt of increased market costs. Banks have been quick to pass on the higher cost of funds to borrowers meaning the historically low, particularly fixed rates, are now but a memory. But it’s not too late.
Fortunately, the variable home loan rates have yet to see the same increases, mainly as the Reserve Bank cash rate more heavily influences these rates, and the Bank’s view to date remains that there is no immediate need to increase that rate. Notwithstanding the Reserve Bank’s monetary policy decisions to date, it is clear from its comments that the possibility does now exist for increased variable rates within a shorter time frame than they had previously been expecting. The Governor is now saying the prospect of rate rises in 2022 is ‘plausible’. For its part, the market generally is now predicting August as the likely timing for the Reserve Bank’s first rate rise since 2010. As recently as 16 February, the Commonwealth Bank predicts this increase will take place in June.
Though no one can see the future, with inflation growing throughout the Western world, there is an impetus for increased price pressures generally, and likely in interest rates too at some point.
Borrowers seeking to hedge their exposure to increased rates should consider a strategy of fixed rates. Though less commonly used over recent years, fixed rates have a role to play now that we are arguably past the bottom of the interest rate cycle. Unlike six months ago, when fixed rates were typically cheaper than the variable rate, the opposite is generally now the case.
It is tempting to go with the lower variable rate in such a situation. This strategy, however, ignores the risk of that variable rate, over time, increasing beyond the level of the fixed rates currently on offer.
What factors to consider when fixing your interest rate?
Many borrowers think that a fixed rate can be inflexible. Whilst this can be true, this inflexibility should be regarded as a trade off for the certainty of the fixed rate. Therefore, when looking at a fixed rate strategy, one of the primary considerations is the level of the fixed rate relative to the variable rate – or the likely variable rate over the term of the fixed-rate contract.
Should there be a need to repay a fixed-rate loan before its expiry, borrowers can get caught out paying an extra cost to unwind an ‘out of the money’ position. What is meant by this is that the fixed rate to which the borrower is contractually committed is greater than the market rate at the time of their seeking to pay it out. The risk of being ‘out of the money’ in this situation is, of course, heavily influenced by the market movement from the time of fixing the rate until the early repayment of the loan. For example, a loan rate fixed today at 3%, will be ‘in the money’ should market rates rise above 3% at the time of early repayment and thus, there would not be a cost to unwind an ‘out of the money’ position. Whether or not to lock in a fixed rate comes down to your view of the future direction of interest rates. When rates are coming off historic lows and arguably trending upwards, an opportunity currently exists to lock in a fixed-rate at a level that should remain ‘in the money’ within a reasonable fixed rate contract length. But again, whether this is the right strategy for you depends on your view on the future direction and pace of interest rate changes.
What should you do if you expect to contribute more to your loan during the term of a fixed-rate contract?
Fixed rates can be inflexible as they usually have restrictions on making additional repayments. As a result, fixed loans won’t suit borrowers who expect to have additional funds that they can use to pay down their mortgage. However, the good news is the total loan doesn’t need to be fixed; a part fixed / part variable arrangement can usually be accommodated by lenders. Borrowers may then set the variable rate loan amount at a level that will facilitate any extra payments consistent with the additional funds you expect to contribute.
What is the process of fixing an interest rate?
As a borrower, it’s critical not to ‘set and forget’ your home loans. A current variable loan can be restructured with a fixed rate on all or part of the debt. Alternatively, refinancing the loan to a new lender presents an opportunity not only to revisit the structure of the loan but also to seek a better deal. This of course, is where your Morrows adviser can help. It’s also worth bearing in mind that you need not wait until its expiry before looking at refinancing it, should you already have a fixed-rate loan.
Can I pay out my fixed loan early?
It is possible to payout your current fixed rate early to take advantage of a better deal currently available. Of course, there may be a cost in paying out that loan if your existing loan is ‘out of the money’. However, this cost may be small compared to the benefits of locking in for a longer period now to secure today’s low rates rather than waiting another year only to find rates have increased further.
How long does the process take? How do you ensure you secure today’s low rate?
Locking in a fixed rate can often take some time, particularly if you are refinancing the loan. Unfortunately, this can often lead to rates increasing during the process. Fortunately, there is a way to secure a fixed rate today and avoid exposure to rates rising before finalising the process. Most lenders offer what is known as a Rate Lock facility. A rate lock enables you to lock in today’s fixed-rate, usually for a maximum of 90 days. Some lenders will charge a fee for this, usually 0.15% of the loan; however, there are some lenders that Morrows has access to that, subject to certain conditions, will provide fixed-rate certainty at no cost.
How Morrows Lending can help
If you have any questions regarding this article or are seeking finance advice, our experienced Lending Solutions team at Morrows can provide you with a range of support tailored to your needs. So please get in contact with Morrows Lending Solutions today!