With the recent hikes in fixed and variable rates by the major banks many property investors are wondering whether it’s a good idea to fix the interest rate on their loans. Read this article for 11 very valid points from Stuart Wemyss for you to consider when contemplating the fixed versus variable dilemma:
WILL YOU LOSE SLEEP IF INTEREST RATES RISE?
There are typically two reasons people are attracted to fixing rates.
Firstly, they think they will be better off financially. This is a flawed strategy because it assumes you have a crystal ball and the reality is absolutely no one knows what rates will do in the short, medium and long term future.
Most experts can’t consistently predict what the RBA will do at their next monthly meeting! What hope do you have?
The second and more appropriate attraction to fixing is for risk management – protecting your downside. If you are the type of person to worry about interest rates and be on edge the first Tuesday of each month (each RBA meeting), then fix a portion of your debt.
WILL YOUR STANDARD OF LIVING (LIFESTYLE) BE NEGATIVELY IMPACTED IF RATES RISE?
If future interest rate increases will put pressure on your household budget, then you need to manage this downside risk and therefore fixing your interest rates is more important for you.
IF YOU ARE GOING TO FIX, START WITH YOUR HOME LOAN (NON-TAX DEDUCTIBLE DEBT) FIRST.
The cash flow impact of interest rate rises on your home loan will be more significant than an investment loan because of the tax deduction you receive for investment debt. For example, if the interest rate on your $500k home loan increases by 1% the cash flow impact is $5,000 p.a. However, if a $500k investment loan rate increases by 1%, the after-tax cost of this is just over $3,000 p.a. after your tax deduction. Therefore, you have more capacity to weather interest rate rises on investment loans. As such, you should consider fixing your home loan first.
WILL YOU WANT TO ACCESS THE EQUITY IN THE PROPERTY IN THE NEXT 5 YEARS?Fixing your loan essentially locks you into a lender for the fixed rate period (because if you refinance you will have to pay exorbitant fixed rate break fees). Locking yourself into one lender might not give you the opportunity to maximise your borrowing capacity and therefore might prohibit you from accessing (and using) the equity in your property to build wealth.
WILL YOU SELL THE PROPERTY?
If you plan to sell the property, then don’t fix as you could be up for exorbitant fees if you sell during a fixed rate period.
ONLY FIX FOR A PERIOD OF 3 TO 5 YEARS.Fixing for 2 years or less provides limited interest rate protection.
The interest rates for shorter periods can, at times, seem attractive but if the purpose of fixing is to manage your risk (and it should be), then 2 years doesn’t provide much protection. Very few Australian’s fix for longer than 5 years.
Firstly, the rates are rarely attractive (because of the lack of demand) and the period is just too long and you forgo too much flexibility.
THINK ABOUT YOUR ABILITY TO MAKE EXTRA REPAYMENTS
Typically, you should have some variable debt (i.e. don’t fix 100%).
One way of approaching this split is to think about how much you can repay, add a buffer and that will be your variable portion.
Then fix the rest. For example, David’s home loan is $850k., David thinks he can repay $25k p.a. Therefore, over 5 years he can repay $125k.
As such, I would advise David to fix in the range of $650k to $700k for 5 years thereby leaving $150k to $200k variable allowing him to still repay as much as possible.
TRY AND STAGGER FIXED RATE EXPIRY DATES TO SPREAD YOUR RISK
If you have a large debt portfolio, then it might make sense to stager your fixed rate expiry periods so that all your debt doesn’t come out of a fixed rate at one point in time. In this regard, you might use a selection of variable, 3 year and 5 year fixed products.
CONSIDER WHETHER A ‘FIXED RATE LOCK FEE’ IS WORTHWHILE.
When you fix your interest rate you receive the prevailing fixed rate at the date of settlement, not the date of application.
If fixed rates change between when you apply for a loan (or to switch) and when the loan is actually established (drawn down), you will get the different rate unless you pay a fixed rate lock fee at the time you apply.
Speak to your broker about this option.
NEVER FIX 100% OF ALL YOUR DEBT
It is always good to have a variable portion so that you can use an offset account (as vast majority of lenders do not allow offsets to be attached to fixed rate loans). Also, as discussed above, most fixed rate products limit the amount of extra repayments you can make whereas the same restriction doesn’t apply to variable rate products.
ARE YOU AN ACTIVE INVESTOR?
If so, fixed rates might not suit you as you potentially forgo too much flexibly and ability to manage your borrowing capacity.
Of course, there might be other considerations to take into account and the above checklist isn’t exhaustive.
Come and speak to me at Volare Home Loans and I can talk you through these very valid points and help make a decision.
Every year when spring rolls around, we're inspired to refresh our home and our wardrobe. But what about our finances?
Take a look at these tips from MoneySmart on how to rejuvenate your finances too.
1. Freshen up your mortgage
Compare your home loan with other loans on the market to see if you can get a better deal. Find out what your current interest rate is and take note of the loan features you want to keep, such as an offset or redraw facility.
Catherine at Volare Home Loans can help you do this.
If you switch to a cheaper loan, stick with your current repayments to save interest and pay off your loan sooner.
2. Put a spring into your savings
Check the return you are getting on your savings and see if there are other financial institutions offering better rates.
Also reconsider the type of savings product you have. For example, if you have a term deposit that's about to mature and you find an at-call savings account that is paying higher interest, ask yourself whether a term deposit is the right account for you.
Alternatively, if you have money in an ordinary savings account but term deposits are paying higher interest, see if you can lock some savings away to get a better return on your money.
3. Reassess your home and contents insurance
We all buy items for our homes from time to time, like appliances, furniture, TVs and electronic equipment. How long since you estimated the cost of replacing the entire contents of your home? Is your current contents insurance enough to cover what you have?
4. Whip your personal insurance into shape
If you couldn't work for a long period of time due to illness or injury, would you still be able to cover all of your living expenses? If not, income protection insurance may help. Check if you already have income protection cover through your super fund or another insurer and see if it is enough.
5. Blow the cobwebs off your super
You might not see super as 'your' money because you can't access it until you retire, but the reality is that it is very much your money and it's going to come in pretty handy when you retire.
To get to know your super better, find your latest super statement (it could be hiding in your email inbox or in your filing cabinet) and have a good hard look at it. Here are some things to check:
6. Rejuvenate your budget
When you've finished giving the rest of your finances a good spring clean, it's a good idea to update your budget. Your income and expenses change over time, so keeping your budget up to date will allow you to track what you're spending and calculate how much you can save towards your goals. Use the budget planner to start creating your budget.
Work out where you money is going and how to make it stretch further.
You work hard for your money, so make it work hard for you. Look for low interest rates on your mortgage and high interest rates for your savings. Keep on top of your insurances and know where your money's going so you stay in control.
Message from CAtherine
Occasionally I come across an interesting article to do with Home Loans. I thought I'd share some of these with you here.