To fix or not to fix? Consider these tips before you lock in your rate
If you’re contemplating whether to fix all (or some) of your interest rate, mull over the following points first to help your decision:
Will your standard of living be affected if the rate rises?
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.
Will you be needing to access equity in the property within the next five 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.
Do you plan to 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.
If you do plan to fix…
Start with your home loan 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 whether interest rate rises on investment loans.
Fix for three to five years
Fixing for two 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 two years doesn’t provide much protection.
Very few Australian’s fix for longer than five 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.
Can you 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.
Try and stagger fixed rate expiry dates to spread your risk
If you have a large debt portfolio, then it might make sense to stagger 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, three year and five year fixed products.
Consider whether a “fixed rate lock fee” is worth it
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.