Note from Kylie: This week, Melissa Cavers from Maplefly Money shares her take on fixed-rate home loans. With interest rates being such a hot topic, her practical insights come at just the right time.
As we approach the next phase in the interest rate cycle, some lenders have already reduced their 2-3 year fixed rates. In some instances, this means the fixed rates offered are less than the best variable rates in the market.
This can be a very tempting offer.
Before jumping in, it is important to have some understanding of why this is being offered.
It comes down to a case of will the short-term savings on a lower fixed rate be outweighed by the premium paid over the entire fixed period should variable interest rates be cut.
Many economic commentators believe fixing an interest rate can be very difficult to judge because, basically, it’s the equivalent of betting against the house.
These are my thoughts on the immediate future of interest rates.
As I’m sure you have heard from various news outlets, the RBA decided to hold interest rates at their recent meeting on 6th August.
I wanted to share my insights into the reasons and why we shouldn’t give up on rate cuts in the short term.
I will preface this by saying that I am firmly in the interest rates cut camp.
However, I believe it’s important to have an understanding of why these decisions are made and cut through some of the hysteria that the media reports.
I want to offer, including myself, some hope about the rates, balanced with being realistic, for what is best for the Australian economy in the medium and long term.
After watching the press conference of RBA Governor Michele Bullock, these are my takeaway points:
- The RBA’s main goal is to have inflation between 2-3%. The latest quarterly CPI data shows it’s currently at 3.8%. Long-term uncontrolled inflation is detrimental to everyone and will result in the cost of living continuing to rise and increasing unemployment levels.
- Therefore, the other objective of the RBA is to achieve this without pushing the economy into recession, especially balancing the risk of keeping the unemployment rate steady. This is what the RBA often refers to as the narrow path it’s trying to tread.
- If inflation continues to decline ‘slow and bumpy’, then rates will remain on hold until late 2025.
- The RBA currently has forecasted a slow and bumpy decline in inflation. Quite often, their forecasting has been wrong in the past.
- Several leading economists from the big banks, who are paid big bucks to forecast this stuff, have projected that inflation will fall faster and unemployment will increase higher than RBA forecasting. If the other economists are right and the RBA is wrong, interest rate cuts could come as early as the end of the year or early 2025.
Some might call me an optimist, but my thoughts are the RBA has been too conservative with its forecasting, and we will see rate cuts at the start of next year.
Overall, the most important part of deciding if taking a fixed rate is determining if it’s right for you and your personal circumstances.
Here are some influencing factors to help you make an informed decision.
Factors to consider
The main benefit of a fixed rate is to provide certainty of a monthly repayment that will not change with normal market interest rate fluctuations. This means you are effectively agreeing that the fixed rate being offered to you today will be the same or less than the variable rate at the end of the chosen fixed period.
There are other factors that you also need to consider before deciding on a fixed rate.
While it does provide certainty, this comes up at the cost of losing flexibility. Most lenders will restrict the amount of additional repayments you can make during a fixed rate period, usually somewhere between $10-$20k per annum. Therefore, this puts a cap on how far your loan can be paid in advance.
The other major limitation is most fixed-rate home loans do not allow offset accounts or redraw benefits. This means that you cannot save on interest charges by having additional funds sitting in a linked offset account or in your home loan balance.
In addition to these restrictions, should you need to sell your property or make certain changes to your home loan, you may be liable to pay a break fee.
The calculation of a break fee does vary and can depend on many factors, like the remaining fixed rate period at the time of breaking and current interest rates. It can be a significant amount, ranging anywhere from a few hundred dollars to tens of thousands of dollars.
