Fixed vs Variable Interest Rates

Hi Guys,

Was wondering given the IR are low.
Should I borrow for my Investment Property on a fixed or variable rate ?
I am told VR is standard and the most common but wouldnt it be ideal lock in a fixed rate given the current low Interest rates ??
 
Good question GaryK - one that's discussed a fair bit on the forums.

Fixing your rate shouldn't only be viewed based on the interest rate - there can be significant break fees involved should you sell/repay your loan and it reduces your flexibility to make changes.

A good reason to fix rates is part of a risk mitigation strategy - by fixing some/all of your portfolio you reduce your interest rate risk.

Cheers,
Redom
 
The point that interest rates are very low at the moment is extremely valid. From a price perspective, it's hard to imagine that rates will reduce further, but it could happen, or rates would stay where they are now for years which might render this argument invalid.

What is often more relevant is flexibility. If you decide to break a fixed rate contract, it can cost money, sometimes this can be quite significant. You may want to break a fixed rate because you need to access equity in the property and the current lender won't accommodate this.

You are also limited in how much extra repayments you can make on a fixed rate loan. They generally don't have offset accounts either. The simple work around for this is to split the loan into variable and fixed portions.
 
Good question GaryK - one that's discussed a fair bit on the forums.

Fixing your rate shouldn't only be viewed based on the interest rate - there can be significant break fees involved should you sell/repay your loan and it reduces your flexibility to make changes.

A good reason to fix rates is part of a risk mitigation strategy - by fixing some/all of your portfolio you reduce your interest rate risk.

Cheers,
Redom

Thanks for the reply Redom.
I assume given historical Rates that the IR wont stay this long for years to come and given that only afew years ago they were at 7 and 8 percent, locking a fixed rate at around 5 would offset the exit fees and other fees that come with a Fixed rate ? Am I right? Am I missing something here ?
 
The point that interest rates are very low at the moment is extremely valid. From a price perspective, it's hard to imagine that rates will reduce further, but it could happen, or rates would stay where they are now for years which might render this argument invalid.

Agree with Peter on this one - much of the fixed rate market is dependent on international factors, rather than domestic funding markets.

Internationally, the price of credit is at record lows (Europe, Japan and US). Over the coming period, it is quite likely that some of these countries will move to more 'normal' interest rate settings - this will likely fuel an increase in funding costs worldwide.

However the timing of this 'normalisation' will be different around the world.

Cheers,
Redom
 
Thanks for the reply Redom.
I assume given historical Rates that the IR wont stay this long for years to come and given that only afew years ago they were at 7 and 8 percent, locking a fixed rate at around 5 would offset the exit fees and other fees that come with a Fixed rate ? Am I right? Am I missing something here ?

I don't think anyone can say with any certainty - but there are some 'drivers' that are worth considering.

I've heard quite a few SS stories of people thinking rates are near the bottom - only to fix their rate and for rates to fall further.

A recession could hit, unemployment could rise - a whole host of 'shocks' could come into play that make variable rates fall further unexpectedly.

Its difficult to say with any certainty whether rates at their lowest.

As Peter and I mentioned above, there are also other considerations to look into other than pricing alone.
 
Thanks for the insight guys.

How can I split a portion of loan to a FR and the other to a VR and is their a 'standard' as to how much for each portion ?
 
Thanks for the insight guys.

How can I split a portion of loan to a FR and the other to a VR and is their a 'standard' as to how much for each portion ?

Your choice GaryK. Can do 10/90, 50/50, whatever proportions you'd like.

Note that some lenders charge accounts fees for splitting your mortgage accounts.

Cheers,
Redom
 
Thanks for the insight guys.

How can I split a portion of loan to a FR and the other to a VR and is their a 'standard' as to how much for each portion ?

There's no set amount - you can split it anyway you like.

If this was your only loan (ie. you didn't have a PPOR loan) then I'd leave enough of the loan variable to offset your future savings over the fixed rate period.

So for instance - if you're taking out a 3 year fixed and you think you'll manage to save $50k over this period, then make sure that your variable split is higher than $50k.

Cheers

Jamie
 
People seem to like some type of arbitrary split. 50/50, 20/80, it's still arbitrary and therefore likely to be in appropriate.

Better to apply some logic to it:

1. Work out how much you've got to put in your offset account.
2. Do a budget, work out how much money you expect to save during the fixed rate period.
3. Add the two together and throw in an extra 10% - 20% to give yourself a stretch goal.

This gives you an amount for the variable portion, which is likely to be useful, but probably won't be so large that it will affect you financially if rates do increase.
 
Back on the topic of will interest rates go up or down...

The argument that rates will increase is fairly simple. Right now rates are about as low as they've ever been. It's hard to imagine that they won't increase. Historically the average interest rates that I remember (since about 1999) have averaged somewhere about 7.0%. It follows that if you fix at a figure below that you'll probably be okay.

Historically during that period (since 1999) we've seen a fairly healthy economy. We took a hit during the GFC but we were relatively unscathed and prior to that the economy was generally doing fairly well. Since the GFC we've had a mining boom which has also helped the economy.

On the other hand, the government is effectively broke. It's politically dangerous to try bring the country back to surplus. With an aging population, restrictions on welfare and healthcare we could be seeing a long period of economic uncertainty. Today The Age ran an article saying our children would be the first generation to have it worse than their parents.

There's plenty of evidence that suggests that the new average long term interest rate might actually be well below 6%.

Personally I don't have a clue. It could go up or down. Treat fixed rates as a risk mitigation strategy rather than a money saver.
 
On the other hand, the government is effectively broke. It's politically dangerous to try bring the country back to surplus. With an aging population, restrictions on welfare and healthcare we could be seeing a long period of economic uncertainty. Today The Age ran an article saying our children would be the first generation to have it worse than their parents.

Agree with your post overall Peter, no real idea which way rates are heading, but I do think the neutral 'norm' interest rate is sub 6%, at least for the medium term.

But the government definitely is not broke. The opposite!

In fact, the public sector purse is INCREDIBLY strong, sustainable and healthy.

The media may have you think otherwise, but the numbers, debt trajectory, international comparisons, and any reasonable benchmark used shows Australia to be in a position of enormous strength.

Regarding Todays article in the Age, I can show you a gloom and doom article about the future most days!

The work that this Government has been aggressively pushing is to change sentiment - to convince the country that the budget needs repairing to pursue beneficial long term structural change. It's effectively a sales pitch by those in charge - the sale of very difficult, but important reforms (e.g. infrastructure push, push to indirect taxes, etc).

If the wider public believe that the Govt is broke, kudos to this Gov't. Their sales strategy is gaining some traction...slowly, but seems to be working.

Cheers,
Redom
 
Is there any reason why the OP couldn't start on variable and the moment interest rates start to rise (assuming it is only a 0.25% increase) he/she switch to fixed?
 
Is there any reason why the OP couldn't start on variable and the moment interest rates start to rise (assuming it is only a 0.25% increase) he/she switch to fixed?

Or Holy Moly, bite the bullet and go fixed. This is one of the few times that a fixed interest rate is a good idea. Really helps you sleep at night. Interest rates are incredible atm. The US, Europe, Japan etc have been down for years - can't go on. Things have already started to get better. US is no longer printing extra dosh. Australia's about to take off again now that our dollar's finally going down. Jobs in tourism, international education, maybe construction, too.
You're not going to sell in the next 3 years, are you? If you can't pay a loan for 3 years, don't do it. Are you intending to buy a whole heap more properties in the next few years? If so, then you need max flexibility and won't want to fix.
If you want to pay it off a bit quicker, keep 10% or 20% variable and then you can either get an offset (reduces interest) to go with the variable or a redraw (reduces principle). There are varying ideas about which is best - SS members are pro-offset.
Banks shouldn't be charging you for that - it should be free. If they charge you for every little thing, go to a credit union. Credit unions treat you good.
 
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