Mortgages - Fixed vs Variable

[Kohinoor]

Most of us get to face mortgages at some time - I figured it was worth knowing a bit more of "Fixed Rate Loans". Some may have never heard of Fixed Rate - while some may WISH they never heard of them....

With the current "easing" of Interest Rates going on, Fixed Rate loans have become an item of concern for some. I figured a quick tutorial might help a few people on here.


So, what are Fixed Loans?
In short, you arrange to "lock" your mortgage Interest rate to a known amount for a fixed period of time. This gives you stability, as your mortgage payments will not vary at all for a fixed period (1 year, 3 years, 5 years, 7 years, etc....).

When should I use Fixed Loans?
In my opinion, Fixed Loans are great AFTER Interest Rates have dropped to wherever they are going to get to. USUALLY, Fixed Loan interest Rates will LEAD the Variable rates. So, when going down, Fixed rates will look lower than the current Variable.

Once this flips around (and Fixed is looking HIGHER than Variable), then is when I look to Fixing my loans (usually for 5 years).


Banks will always allow you to FIX a loan at no charge, and at any time. But, if you wanted to move back to Variable Rate, then there is a "Break Cost" to get out of a Fixed Loan. And, at times like this, with Interest Rates dropping like never before, this is NOT good news for anyone with a Fixed Loan.


Right now is a GOOD time to stay with a Variable Loan (the usual). Rates are dropping, and looking like dropping more. It's also a good time to CONSIDER looking to a Fixed Loan. Imagine if you are able to "lock in" an Interest Rate of 5.5% for the next 5 years (compared with the 9% we were paying only 3 months ago...). Would you want to do it?

If the answer is Yes, let me add just a little more - first off, one of the MAJOR reasons to NOT go Fixed is the in-flexibility of this Loan style.

1. You can't use an Offset account against them
2. You are often limited as to how much you can "pay off" these per year
3. If you wanted/needed to Sell, then you would be facing a "Break Cost"
(which could be quite nasty, see below...)


Break Cost:-
If you wanted/needed to "break out" of a Fixed Loan, the Bank will nominate a Break Cost. Now, these can seriously hurt, depending....

1. If you are breaking out of a 7% loan, and Variable is 7.5% or more, then there may be little, or no, cost to you.
2. Conversely, if you are breaking out of a 7.5% Fixed Loan, and Variable Rates are 7%, you will be up for some serious $$ to break.
3. The larger the difference (Variable being Lower) the HIGHER the cost.

Today, with Variable Rates dropping like a stone, the cost of breaking a Fixed Loan is going through the roof. So, I'd suggest anyone looking to "break" any current Fixed Loan to seek some seriously good advice beforehand. It may cost you $25,000 to break out of a Fixed Loan, while the expected reality of going to a lower Variable might only return $15,000.

So, DON'T be in a hurry to Break any Fixed Loan.


And, for those of you who have a Variable Loan, now is the time to start looking at Fixed as an option. We are at (or near) the RIGHT end of things to be Fixing.... But, be aware of the limitations of doing so (see points 1 to 3 above)

Koh

[ConnieK..]

koh,

We have half our mortgage fixed at 5.5% and half variable. Helped a lot when rates were volatile as we knew one payment was always going to be the same. We can pay an extra $12500 per year with no penalty and our break costs are minimal. Our fixed period ends in January ( 3 years) and we agree to stay with the bank in question for a further 2 years at variable on this loan. As we built a new house we figured we weren't going anywhere for 5 years anyway and the stability of knowing half our mortgage payments for that 5 years was very nice when rates jumped to 9. As a result the fixed half has been paid off quite a bit more over the 3 years than the variable, despite the fact we have an offset account with a substantial balance.

Just a perspective from one who has a fixed AND variable mortgage

Connie

[Kohinoor]

Good one, Connie,

Having "two bob each way" is certainly useful eh? You did well to get a 5.5% Fixed 3 years ago (was it part of that "deal" - i.e. stay Variable for two more afterward?) Boy, you've lucked in there for sure

Fixing HALF could have helped those who chose to Fix at higher rates (only half the pain when Variable dropped) - so thanks for the comment.

All good for learning on a generally unfamiliar subject,

Koh

[Kohinoor]

Time for a "bump" for this one !! In the last week or two, the Banks have been cutting Fixed Rates again (and all WITHOUT any RBA input!!)

What if the RBA also drops the rate? That will put even more pressure on a "downward movement". But then, Banks are what they are, and they do what they do - so no guarantees. And, since the Banks have already done this, it will take pressure OFF the RBA from doing likewise.

Back to the first post though - Fixed Rates often LEAD Variable, so, if Fixed are going down, Variable Rates may well follow. No surprise to me, as I watch the World Markets seemingly going into melt-down. I haven't seen times like this in my memory - so even using "old mantras" is somewhat dangerous. i.e. Who says Fixed Rates lead Variable, and will continue to do so ?

Once more, though, we "appear" to be in the right time/space to be looking at Fixed Rates.

DO check the first post re the dangers of doing this - if they don't apply to you, then looking at Fixed Rates now/soon could be beneficial.

Like before, I need to stay flexible - so, I won't be fixing - no use payng a HUGE Break cost if I needed to sell something But it might be beneficial for others (specially if it allows you a 15% drop in Interest from what you are paying now)

Koh

[Kohinoor]

I was just going to update this (as things continue to change) - then, on re-reading, I noticed THIS comment of mine :-

But it might be beneficial for others (specially if it allows you a 15% drop in Interest from what you are paying now)

Of course, if you hadn't read my other thread "Why are Rents so High?" then the significance of that comment may be lost on you.

See, when we talk of Interest Rates, the talk is usually in increments of 0.5%, 0.25%, or 1% - really small numbers. But, as explained in that other thread, the REALITY is quite different. Here's a quick example :-

Someone has a Variable Loan at 6% Interest in 2007 on a $400,000 mortgage. The Interest payable is $24,000 a year (about $2000 a month). This DOESN'T consider "paying down Principal" at all - I am dealing only with the Interest component here.

In 2009, Interest Rates screamed up to ~9% - so, the Interest rate was "said" to have increased by 3%, but the REALITY was that payments increased (from 6%) by 50% (now paying $3000 a month in Interest).

Now, with Interest Rates heading South, it doesn't take too much to see a 15% drop in real Interest Rates - here's another example :-

Someone has a Variable Loan at 7% Interest in 2011 on a $400,000 mortgage. The Interest payable is $28,000 a year (about $2300 a month). Then the Interest Rate drops a few times (0.25% here, 5% there) and the actual Interest $$ paid falls by 1%. With me?

So, that 1% drop from a 7% start, is really a 14.3% drop in real Interest paid !! Not quite 15%, but looking pretty nice.


In essence, our payments NOW, are back to mid 2007 levels, and MUCH easier to maintain - woohoo !! Anyone still looking to Fix their rates would do pretty good by doing it now/soon.

The only caveat to that comment is "the rest of the world" - especially Europe right now. Further strain from that area could well impact even more on the overall world economy, and lead to even lower Interest Rates.

So, do you Fix now? Hmmm..... my crystal ball is in for repairs at the moment..... how's yours?

Koh