When you take out a loan to purchase a property, whether for investing or to live in, the process is littered by lots of little decisions along the way.
Choosing a fixed or variable interest rate for your loan is often one of the more meaningful finance-related decisions you’ll consider, as the right mortgage choice can save you heaps of money – while the wrong choice could fill you with regret.
The difference between the two is subtle, but impactful.
For example a variable interest rate is one that changes throughout the loan term in relation to market fluctuations.
Meanwhile, a fixed interest rate is one that is set at the beginning of the loan term, and remains the same throughout that period, regardless of what happens in the broader market.
With mortgage interest rates about as low as they can get, some investors are wondering whether they should consider fixing their interest rate.
Both options have their pros and cons, and while a variable interest rate might be more popular in the current mortgage market, there are a few reasons why it may be worth considering locking into a fixed rate.
If you’re weighing up which option is best for you, consider the following:
Interest rates are low now, but anyone who has had a mortgage for longer than a few years knows how quickly mortgage markets can change.
In the current climate, that's unlikely to happen soon any time soon, but having a fixed interest rate provides peace of mind of knowing exactly how much you’re going to spend.
It means you know how much you’re repaying on your loan, for the medium- to long-term, as the lack of potential rate changes means your repayments won’t change, and there will be no surprise rate rises to budget for in a year or two.
Speaking of rate rises, having a variable interest rate leaves you vulnerable to the dreaded rate rise.
Right now, economists are not predicting rate rises any time soon.
In fact recently the RBA suggested rates are going to remain low for three years.
But if the economy picks up quicker than expected and interest rates do increase, it could put a severe dent in your budget, if you aren’t reasonably well prepared for it.
Keep in mind that an RBA-driven rate rise isn’t the only increase you need to be wary of.
Banks and lenders can introduce rate rises whenever they like, for a range of reasons; if the cost of funding increases, for instance, or if they wish to lessen their exposure to a segment of the market.
This happened a few years ago when APRA rules changed, and banks had to shed investors from their loan books.
They did this by adding a premium to their investment and interest-only loans, which saw investors paying up to 1% more in interest than their owner-occupier counterparts.
If the prospect of interest rates increasing makes you nervous, then fixing your mortgage interest rate could be the right idea.
Those who are relatively new to borrowing may not be aware that you can allocate a portion of your loan to a fixed rate, and another portion to a variable rate.
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This is known as a split and it essentially allows you to have the best of both worlds, as you can enjoy the security that a fixed rate offers on part of your loan, while benefiting from any interest rate reductions on the variable portion.
By retaining at least a portion of your loan as a variable rate product, you’re able to make good use of an offset account, to maximise your savings (as these are not generally allowed on a fixed rate loan).
Offset accounts act as a transaction account that is linked to your loan, and by keeping money in there, it directly impacts the interest you pay on your loan.
For example, if you had a loan of $500,000, and you also had an offset account that held $50,000, you’d only be charged interest on $455,000.
The more money you have in your offset account, the less interest you’re charged.
These savings can quickly add up!
Utilising a fixed interest rate can be a very effective risk management strategy. As an investor, you will have a risk appetite: it may be low, medium, high, or somewhere in between, but it definitely falls somewhere on the scale.
It’s essential that you take any perceived risk into account when making property and finance decisions.
For instance, while you might pay a bit more in repayments with a fixed rate loan, the risk mitigation involved in securing a fixed repayment, which allows you to sleep peacefully knowing you won’t experience an interest rate rise, may be the ideal risk mitigation strategy for you.
The decision to opt for fixed or variable is a personal choice and it depends on a range of factors.
With proper planning, you can devise a loan repayment strategy that suits you and your particular circumstances, and propels you towards your financial and property goals.
If you’re stuck on this decision – or any other decision related to property investing – you may need a little expert guidance.
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