If you own property, at some stage you’ve probably had to decide between variable and fixed interest rates. Today we discuss why you shouldn’t fix your interest rates when it comes to your home loan or rental property.
Many of our clients who are close to retiring will remember the days when interest rates were somewhere between 15 and 17%. It’s understandable that they would want to lock in a rate of 3 or 4% when compared with that. But in theory, locking in a fixed rate is a bad idea. Think about it from the perspective of the financial institution. They wouldn’t give you the option to fix the rate if they thought it would benefit you rather than them. Banks don’t offer these options out of the goodness of their heart! But they know that for some customers the fixed rate is important.
The rule of thumb over different periods of time has been that having a fixed rate will see you paying an extra 0.5% rather than if you had a variable rate. In a way, it’s a bit like paying insurance for the rate to stay as it is.
When people lock in an interest rate, they only worry about the rates going up. They don’t tend to think about them going down; and will lock them in for 3-5 years. But the fact that interest rates are so low right now doesn’t mean they won’t keep getting lower. On average, fixed rates have to be higher than variable rates – banks simply wouldn’t take on the risk otherwise.
Michael has been in the finance industry for over 20 years, and in that time he’s seen many people lose out to fixed rates. At the start of his career the rates were up and down, but over the last few years they have mostly been going down. In any case, he has hardly seen anyone ‘get it right’ with a fixed rate. It’s a little like changing your super or investment strategies – or doing things reactively, which is never a good thing. When rates go up, people worry, and react by fixing their rates. But we recommend that people stick to a variable rate simply based on the statistics, and on what we see personally.
Of course, this isn’t us making a call on the market – we’re not saying the rates will keep going down. Nobody can predict that – we can’t tell the future. This is simply our experience and the averages we have seen over the years.
In fact – fixed or variable, the most important part of a loan is having a successful plan to pay it off. Many young couples are buying properties and taking out loans for 95% of the cost of the home. They are just scraping through to make their mortgage repayments, and so they feel like fixing the rate is the safe option. In this case they probably shouldn't be buying that property in the first place – especially those wanting to have a baby a few years down the track – which will, in most cases, mean less income and higher expenses.
As always, a good financial plan is the best thing you can have in place.
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Dallas Davison, Michael Hogue and Ali Hogue.