To fix or not to fix...!

From: J Parker


Ah, the dilemmas facing us all without that crystal ball! Just deciding what to do with our last IP- currently paying 5.6% variable on an IO loan but am dithering over fixing the loan to a 5 yr fixed. Trouble is it will up it to 7.6%- Ouch!! That's a diffence of about $5K a year. The rental return at the moment isn't great either.

What are other investors out there doing? I know I could fix part of it and hope that covers me enough if interest rates take a serious hike over the next 5 yrs but... then again, who's to say they will surpass 7.6%?

Opinions please!
Cheers, Jacque :)
 
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Sim

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Reply: 1
From: Sim' Hampel


Fixing rates is essentially taking out an insurance policy.

If you look at the numbers... historically it is fairly rare that people who kept their rates variable ended up paying more overall than those who fixed - especially after inflation is taken into account. This is because of the buffers built into the fixed rates - as you mentioned you are paying way less than 6% right now, but 5yr fixed are close to 7%.

You should do the sums and work out the potential cost of fixing verses the risk of not fixing. The biggest issues here are of course that you don't know what variable rates are going to be doing over those 5 years. So it's a lot about peace of mind and being able to budget - knowing what your repayment commitments are going to be over that period.

From a fixed point of view... assuming that rates will not drop any further than they are now... the worst that can happen if you fix rates now is that rates stay at this low rate for the entire 5 years you fix for. So work out how much more interest you will pay by fixing in this case. Think of this as your insurance premium.

Think about whether you think variable rates will go substantially above 7% ? The savings you face if they do but you have fixed your rate is your insurance "payout".

So what am I doing ? Right now all my loans are variable - but that's because I am no where near my limit in servicability, so I'm prepared to take that risk. However, I am seriosly considering fixing my next purchase, especially if it turns out to be slightly negatively geared and I'm buying it as a long term hold. I haven't decided yet. Let me know if you get that crystal ball working !

 
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Reply: 2
From: Simon and Julie M


Hi Jacque
I believe it is always good to employ a sound safety net strategy when investing. The object of the exercise is to buy time.
Some such strategies are:
Keep 20%+ equity in your portfolio. Build up adequate short term funds supply ie. Savings, shares, healthy credit cards etc.
If things get tough it's the investors who can stay in the game who come out the real winners.
In regard to fixing loans I believe it comes down to feeling comfortable with whatever decision you make.
Hope this helps
Kind regards Simon
 
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Reply: 3
From: Rolf Latham


Hi Jaque

For one to break even at 7.6 vs 5.6 over 5 years you would need a fair bit over the 7.6 mark to make up for the lead up to the 7.6.

7.6 for 5 years is double ouch, Heritage still doing 6.75 at a pinch and Westpac 6.99.


Ta

Rolf
 
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Reply: 4
From: KJL .


I might be stating the obvious, but remember that the extra interest you pay is tax deductible, so (depending on your tax position) you may be cushioned from some of the blow anyway.

I've just fixed two IP's for 5 yrs in the last 6 months. I've read several times over the last few months that interest rates are at their lowest in 40 yrs, which can only happen every, oooh, I dunno, 40 yrs or so... ;0)
 
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Reply: 4.1
From: Asy .


Hmmm....

Here is my humble opinion on fixing rates:

The banks employ some of the best economic forcasters around, they have to! These forcasters predict what interest rates are going to do over the next 2, 5, 10 etc years.
The way the bank sets their rates is that they take the forcasts over the set time, say 5 years, then add a .5% safety margin.

It is true that they can be wrong, in which case you MAY be better off fixing, but on the whole, barring nuclear war, I don't think so.

Having said this, I quite like the idea of knowing exactly how much I am going to pay for the duration...

But again, it's a personal decision.

asy :eek:)



"Don't forget what happened to the guy who suddenly got everything he ever wanted...
He lived happily ever after.
(Willy Wonka).
 
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Sim

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Reply: 4.2
From: Sim' Hampel


On 3/27/02 7:47:00 AM, KJ L wrote:
>
>I might be stating the
>obvious, but remember that the
>extra interest you pay is tax
>deductible, so (depending on
>your tax position) you may be
>cushioned from some of the
>blow anyway.

This doesn't mean anything in reality. The interest you pay at 6% is deductible, as is the interest you pay at 8%. Assuming you do not change tax brackets as a result of the interest rate rise, you will still face a 33% increase in your after tax interest expenses as a result of an increase in rates from 6% to 8% !!

 
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Reply: 5
From: Rolf Latham


Hi all

Have just received my latest update to Residex Service.

On the subject of rates and capital growth:

Quote:

In 2005 we will have home loan interest rates of about 9%pa. This translates to an increase in home loan repayments of about $200 per month per $100,000 of borrowing. On the face of it this sounds quite significant. However, we must recognise that this increase in interest rates is a consequence of increasing inflation due to a growing economy which will result in wages increasing. While many will find this a little difficult it will in all probability be insufficient to cause the majority of home buyers any significant problems. The crunch is more likely to arrive some where in 2007–2008 when home loan interest rates could be in the vicinity of 12%pa.

It is important to note that the actual capital growth in our housing market is not driven so much by interest rates but more by supply. Low interest rates have a tendency to stimulate demand and sales activity and where there is limited supply as is the case now, we have growth.

Unquote

I would post the lot, but would probably get into strife with it being a subscription only service.

Those that want the whole article know where to get it.

ta

Rolf
 
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Reply: 5.1
From: B F


Variable is cheaper than fixed in the long term. If you have the cash flow to cover an interest rate hike stay variable. If not go fixed.

If you aren't sure, go fixed. Don't gamble with your investment, just ask some of the investors that took the gamble in the late 80's.

BF
 
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Reply: 5.1.1
From: J Parker


Thanks all for some interesting fodder to chew on. In the end, like Sim says, it is like an insurance policy and I know that the end decision is with me. Great input!
Cheers, Jacque :)
 
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Reply: 5.1.1.1
From: Robert Forward


My thoughts on fixing or not fixing is simply, what way gives you the freedom to do what you want?

Are you willing to lock away a property and not be able take out any equity to make further purchases. So if the market goes into a good buyers market and you've got equity in your existing property are you willing to pay the break costs to get out of it to make the purchase.

I understand that there would be other ways around the above by getting a LOC or such on top of your locked in portion. But personally I like the flexibility of being able to refinance when I want to, by who I want to, and to make another purchase at the drop of a hat without jumping through to many hoops to secure that purchase.

Cheers
Robert

Property Inspection Reports @
http://www.creativefinance.com.au

The Sydney "Freestylers" Group Leader.
 
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Reply: 5.1.1.1.1
From: Waverly Bay


I am not entirely satisfied that fixing rates is tantamount to taking out an "insurance policy" to "protect" against the risk of higher future interest expenses.

When an insurance policy is taken out, you are outlaying a fixed premium in return for a financial payout. Also, the maximum loss you will incur under an insurance policy is the premiums outlayed.

So for example, under a car/home/life/contents insurance you are assured a pay out for which your maximum exposure/expenditure is always only the premium paid.

The same can be said for derivatives such as a put option.

However, the "premium" you pay for fixing rates (ie the differential between the prevailing variable and the fix rate) is not your maximum exposure ! If you mistime the fixing of your rate, then your exposure can be more than the premium you pay for having a fix rate position !

The statistics show clearly that a majority of borrowers fix rates at the wrong part of the interest rate cycle - - - - so that on a refinance, they end up with nasty break costs !

Therefore, the position I take is that when you fix rates you are not buying an insurance policy: you are trading the interest rate markets. You are a trader. In trading terms, you are long interest rates. You are BETTING that for the duration of your fixed term, the variable rate will be higher than your fixed rate. In fact, if you are worried about market rates rising, why not call your broker and short bonds? Buying a fixed interest rate position is no different to taking a short position on the bond markets.

And because the "mums and dads" borrowers are not skilled to understand the intricacies of the interest rate markets, their gamble more than often fails - resulting in break costs upon refinance.

My view is simple - and it is my view only of course - - - if you want a real hedge, a real damn good but simple protection against being cleaned out by future interest rate hikes - then monitor and control your gearing levels.

That said - purely from a trading perspective - if you need to fix, if you need to take a "punt" on the future direction of interest rate - then now would be the time for it. Good luck

cheers

Waverly
 
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Reply: 5.1.1.1.1.1
From: J Parker


Robert,

Forgive me but I am confused by your post. How is fixing the rate going to prevent me from getting the property revalued to access the equity? I already have a loan on a unit that is fixed (at 6.95%)- purchased last year. I recently got this unit revalued and had $40K equity realised. The new sub loan of $40K isn't yet fixed. This wasn't a problem at all. Can you explain further what you meant?
Cheers, Jacque :)
 
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Sim

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Reply: 5.1.1.1.1.2
From: Sim' Hampel


Great post Waverly Bay ! Thanks.

 
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Reply: 5.1.1.1.1.1.1
From: Robert Forward


Hi Jacque

Yes, I did say there were ways around the fixed interest rates. This is via sub loans like you said.

But what would have happened if they weren't willing to give you the valuation you wanted?

Would you have moved to another bank that would have given you a higher valuation and paid the break costs?

This is where I believe the flexibility of staying on variable is worth it. But again it all depends on your circumstances and strategies you are using.

Cheers
Robert

Property Inspection Reports @
http://www.creativefinance.com.au

The Sydney "Freestylers" Group Leader.
 
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Reply: 5.1.1.1.1.1.1.1
From: Rolf Latham


Hi Robert and Jax

The point I feel is, where fixing long term there is ALWAYS a risk that you may sterilise future equity growth. One because of the val as you have mentioned, and two because you may not have the serviceability with the existing fixed rate lenders model.

SOme lenders will allow second mortgages to be used as either collateral or to pull cash, and that is another way out of the pickle.

Fixing is OK (and mandatory in some cases) in my view, just protect your options.

Ta

Rolf
 
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Reply: 5.2
From: Ctrader .


In response to the Residex quote posted by Rolf, I thought this may be of interest.

http://www.cpaonline.com.au/03_publications/02_aust_cpa_magazine/2000/21_sep/3_2_21_property.asp

Tony Crabb has a book out,sorry can't remember the title, in which he discusses his thoughts on the factors contributing to house prices. Although a number of factors have a bearing, his belief is that the number one factor is the interest rate.

Although Residex feels that 9% is not that high, I would have to wonder the effect of people who borrow to the max while rates are low eg. 6% and suddenly realise that their payments have jumped 50% ( 3% difference on 6% is a 50% increase ). Life may become a little more interesting for them at this time.

Ctrader
 
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Sim

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Reply: 5.2.1
From: Sim' Hampel


Just to re-emphasise the point made by Ctrader...

If you have interest payments of, say, $1000 per month when interest rates are 6%, when they reach 9% you will need to pay $1500 per month in interest, and when they reach 12% you will need to pay $2000 per month.

I know this all sounds simple, but I am alarmed at the number of people I talk to (mostly owner occupiers who have borrowed as much as they can to buy their "dream house"), who do not actually understand what an interest rate rise of 6% to 9% would do to them !

Think of it this way. When you bought that property when interest rates were 6%, could you have afforded to buy another identical property at the same time ? Why didn't you ? You couldn't have afforded the repayments on two houses ? Do you realise that you will be paying as much interest on one house at 12% as you would on 2 identical houses at 6% ?

I'm sure most IP investors out there are aware of how all this simple mathematics works, and have worked out a strategy for dealing with the interest rate risk. But I do unfortunately know of people who refuse to acknowledge that risk or deal with it... "times have changed... interest rates will never go that high again". *sigh*.

PS. I'm not saying don't buy property... just make damned sure you go in with your eyes wide open and manage the single biggest risk you have as a property investor... interest rates !!

 
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Reply: 5.2.1.1
From: KJL .


Before I start, feel free to rip this post to pieces - I'd rather know I've got something wrong now than after I've embarked on a particular strategy!

I thought Waverley's post was valid, but it's difficult to keep gearing to managable levels in the early years - which is obviously where some of us are in our journey.

So Sim's point in the previous posting is bang on - "manage your risk" is the key concept, especially for those with mortgages on IPs which might be overall at 80% or even more.

And unless anyone can suggest other strategies to me, then fixing at, say, 6.99% for 5 yrs means that I know with certainty what I have to pay and a hike of to 12% (which isn't out of the question if Rolf's earlier post is correct) won't kill me, even though I may suffer cashflow wise in the short term by paying 6.99% fixed as opposed to 5.5% variable.

I may even suffer more if rates drop further - but that's something I'm prepared to live with in order to manage my risk. Personal choice, and all that.

By the time the 5yr fixed period is up, and if interest rates are at 12%, then rents (and wages) rising naturally should have overtaken what any increased loan obligations are on these properties. What have I missed?

KJL
 
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Reply: 5.2.1.1.1
From: Projects .


Nobody knows for sure what the future will bring, not Residex, not the banks, not Financial Advisors, not the Government and not even us. It is a matter of being aware of what may happen, what it means if it does happen and according to our own individual situation, knowledge, experiences and risk profile how we prepare and react to the different scenarios that may arise. If you feel fixing is relevant to you then don't feel it is wrong because someone else prefers variable interest. You must do what you feel is right for you. This goes for the rest of your strategy as well.

Projects

There is more than one way to climb a mountain.
 
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