Are you buying a family home or an investment property? Maybe you’re interested in refinancing. One question you may be asking is whether you should fix your home loan. With the OCR at record lows, many people find the prospect of fixing their interest rates appealing. But there are a number of things that need to be considered.
It’s nearly impossible to predict what might happen to the economy and interest rates in the future. It is, therefore, crucial to gain as much insight into the benefits and risks of fixed and variable home loans as possible. This way, you can make a decision that is suitable for your circumstances and the time period for your home loan.
Fixed Home Loans
When fixing the interest rate for a home loan, lenders look at the cost of holding money at a certain rate for a certain period of time and then determine the interest rate accordingly. Fixed rates could be deemed predictive for this reason.
If a lender expects the cash rate to rise, they will generally fix a rate higher than the current variable rate. If the cash rate is expected to fall, the fixed rate tends to be lower than the variable rate. Borrowers usually opt for a fixed home loan if they are anticipating that the variable rate will rise above what they have locked in.
Lenders generally offer fixed terms between one and five years. Once the borrower has locked in a rate, they will begin paying the fixed interest rate immediately.
Advantages of a fixed rate include:
● Easy budgeting - You know exactly what you’re repaying, unlike variable rate loans where repayments can vary as rates change
● Security – Ensure that you will be able to afford the loan and meet repayments by knowing exactly how much you’ll be paying
● Rate rises don’t matter - If the cash rate rises above your fixed rate, you can feel happy knowing you are paying less
● Rate drops will be frustrating - If the cash rate falls below your fixed rate, you’ll be paying more than the variable rate instead of benefiting from this drop
● Break fees - Fixed rate loans often have a break free if you change or pay off your loan within a set period, for example, if you sold a property.
Variable Home Loans
Variable home loan interest rates fluctuate approximately in parallel with the Reserve Bank’s official cash rate (OCR). Variable rates shift as a reflection of the current economic climate.
The OCR is generally used as a blunt instrument to try control inflation. When inflation is getting high (indicating a well-performing economy), the cash rate goes up. When the economy is weakening (inflation usually lower) the cash rate goes down.
Having a variable home loan can be highly beneficial when cash rates are expected to drop. For example, borrowers with fixed-rate loans got badly burnt during the Global Financial Crisis, when interest rates plunged. But this scenario is pretty unlikely, especially with today’s low rates.
Advantages of a variable home loan include:
● Flexibility - Variable home loans generally come with more features such as a redraw facility and the ability to refinance or break without incurring significant additional costs
● Extra repayments - Unlike fixed rate home loans, you have the ability to make extra payments at no cost
● Rate drops will be beneficial - If the OCR continues to drop as it has recently, you can benefit with a variable home loan
● Rate rises - If the cash rate were to rise significantly and unexpectedly, it could be stressful and financially damaging
● Uncertainty - It’s difficult to budget and plan your finances over the term of the home loan as it’s hard to predict how much rates will fluctuate or rise
Splitting Your Loan
Another option is to bet both ways and fix part of your home loan. Some people fix half of their loan and keep the other half variable. This allows them to manage some of the risks of interest rate rises while still being able to take advantage of the flexible options available under variable loans, such as making extra repayments.
When deciding how you should structure your home loan, you should consider three important factors:
● What is the current variable rate?
● What are the current fixed rates with your lender?
● What loan features do you need to be able to use?
If you would like some guidance to help you decide, get in touch with Wealth Health. We’re based in Papamoa and can visit clients in Tauranga, Waikato, Mt. Maunganui and the wider Bay of Plenty.
We assist help our clients obtain great mortgage deals, insurances, plus we offer specialist financial and investment advice. For all inquiries, call Craig on 027 667 2537 or contact WealthHealth online. Check out our blog section for great tips and articles.