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Fixed Rate Loans: Is it Good for Long Term?

by | Jun 15, 2020 | Blog | 0 comments

In short, yes it is a good time to try out fixed rate loans. As long as you won’t be discharging your mortgage during the fixed rate period by selling or paying out your home.

There can be some steep break costs associated with breaking the fixed rate period. Also there is no offset facility with many fixed rate loans. You can consider fixing some but not all of the loan if the offset account is effective for you.

Finally if the current COVID-19 outbreak has you in financial hardship, you should refrain from fixing your loan. That’s why we always suggest to contact a finance specialist to discuss your position.

It is always a balancing act to discuss fixing interest rates on debt. The statistics tell us that borrowers lose more often in the long term when fixing rates. At least if compared with the opportunity cost of variable interest rates. This can be from moving too early, or more commonly too late in the rate changing cycle. It is also because financiers need to win the risk they are taking too.

Is Fixed Rate Loans Good for Long Term?

In understanding longer term plans and objectives, fixing interest rates may or may not be a part of your strategy. Fixing can provide certainty for cash flow but there are risks too. A key consideration is the period of time that you see opportunity or risk.

In the past, for many finance advisers, the discussion is centered around a scenario or stress testing.

“How will it impact you if interest rates increase by 2%?”.

With the more granular review of cash flows now, there is better awareness of potential risks which is a positive thing. For commercial lending, we are seeing funding costs and delivery rates increase considerably (albeit off a low base), make sure that you do the necessary investigation to see what structures and pricing is available.

The conversation on fixing should primarily focus on:

– Whether there will be material changes to the loan or your circumstances during the fixed loan term considered?

– Whether you really need the functionality and flexibility of variable interest rates?

As we outlined, borrowers do get this wrong, more often than not.

Looking in Hindsight – Fixed Rate Loans History

So what else does history tell us?

Take the popular 3 Year P&I Fixed Rate for Owner Occupied Home Loans. We can look at all 3 Year Fixed Rates up to April 2017 – and roll forward to compare it with the average discounted variable rate over that period (i.e. in this example April 2017 to March 2020).

Date Fixed Rate at Date Average Variable Rate

(Over 3 Years)

Variable Savings
April 2010 7.58% 5.75% 1.83%
April 2011 7.11% 5.24% 1.87%
April 2012 6.11% 4.67% 1.94%
April 2013 5.14% 4.27% 0.87%
April 2014 4.90% 4.03% 0.87%
April 2015 4.50% 3.82% 0.68%
April 2016 4.15% 3.74% 0.41%
April 2017 3.98% 3.67% 0.31%

As you can see, over recent history, the variable rate has always shown to be the better option.

Though a couple of things to note on the fixed rate loans table:

– The fixed rate generally started at a premium to the variable rate; and

– This period was during a cycle of falling rates.

Our analysis goes back a lot further, and there have been four clusters of months where fixing was a good option.  Interestingly, they usually come out of previous periods of economic downturn, with the last time there was benefit was just during and out of the GFC in 2009.

The gap has narrowed significantly though, and this is not unexpected when approaching the bottom of an easing cycle.

So to answer the actual question, to fix or not?

Monetary Policy

Monetary policy (via the Reserve Bank) may be less relevant but it is still the main driver of variable interest rates. We are now also in Quantitative Easing, so further cuts to variable rates are unlikely, albeit that low rates are with us for a while yet.

Money Market

The best guide for fixed rates is the money markets as they are generally based on the free market. So with market rates low (the 3 Year Swap is crazy) with RBA intervention, it is no surprise that fixed interest rates are also so low at present.

In Conclusion

3 Year Fixed Rates for example are around 2.30%, and you consider their value. The answer is the opportunity cost of the variable rate. You will be say 40 basis points (0.40%) behind initially, by not taking the fixed rate offer.

The question is then whether you can forecast that the variable rate will spend more time below 2.30% over the 3 year term?

It looks increasingly unlikely. As a sweeping comment too, the fixed rate benefits on investment mortgages and commercial loans is greater so this is well worth looking at.

Still confused about Fixed Rate Loans? Key Choice Group will help you out. Feel free to contact us and we will help you out.

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