Blog

Here’s an interesting fact that’s worthy of discussion:

Many Australians are currently choosing higher variable home loan rates, even though lower fixed-rate options are readily available.

To be specific, many new homeowners or first-time buyers are entering into mortgage agreements with variable rates around 6.2%, despite the availability of lower fixed rates at approximately 5.89% for two years.

This decision is most likely influenced by predictions from the Reserve Bank of Australia (RBA) and bank economists, who expect a significant drop in interest rates in the next 18 months.

The question is, why is this occurring, and what should you do with your mortgage?

Let’s unpack the layers behind this decision, by looking at the relationship between immediate financial benefits and anticipated economic changes.

What’s at stake with fixed vs variable rates?

Choosing between a fixed and a variable home loan rate involves weighing potential risks against possible rewards.

Currently, borrowers face the decision to either:

1. Lock in a fixed rate of approximately 5.89% for two years,
2. Opt for a variable rate, which stands slightly higher at around 6.2%.

The primary attractiveness of the variable rate, despite its higher initial cost, is tied to the economic forecasts suggesting a significant rate drop in the coming 18 months.

Economists are predicting a decrease by as much as 1.2 to 1.5 percentage points, which could reduce the effective interest rates over the life of the loan, surpassing the short-term savings offered by fixed rates today.

However, the variable option is not without its risks. If economic conditions change, or if the predicted rate decreases do not materialise, borrowers with variable rates may find themselves paying more than if they had fixed their rates.

Moreover, the fixed rate offers stability and predictability in repayment amounts, which is highly valued by those who prioritise budget certainty over potential savings.

So, it seems that the decision to choose between fixed and variable depends on someone’s:

• Financial stability
• Risk tolerance, and
• Ability to forecast and adapt to economic changes.

Step 1: Get the information to make an informed decision

You’re probably wondering what YOU should do. Let’s explore this.

Firstly, you should gather information that will help you make a decision. Here are some sources:

ASX Rate Predictor

One great tool is the ASX rate predictor, which provides forecasts based on future market data, helping borrowers gauge potential rate movements. Consulting this tool can offer insights into whether rates are likely to rise or fall, aiding in the decision of whether to fix a rate or stay variable.

Reserve Bank of Australia (RBA) Notes

Additionally, the Reserve Bank of Australia (RBA) releases notes that are important for borrowers to review. These notes often contain valuable information about inflation trends and economic forecasts that can directly impact interest rates. Lower inflation usually prompts the RBA to reduce interest rates to stimulate spending and economic growth, which in turn influences whether it might be more beneficial to opt for a variable rate.

General Education

Another tip for borrowers is to stay educated about broader economic indicators and trends. Understanding factors such as global economic conditions, domestic economic policies, and even geopolitical events can provide context for what might happen with home loan rates in the near future.

Step 2: Set your benchmark for action

Second, it’s a good idea to decide the ‘trigger’ that helps you choose when to lock in a fixed home loan rate.

For instance, you might decide that a fixed rate of 4.99% for two years is an attractive threshold to commit to (or perhaps an investment loan at 5.9%).

This proactive approach means you can respond swiftly when the desired rate is available, maximising potential savings (and minimising regret).

It also provides a framework for regularly reviewing and adjusting your financial strategy in response to changing economic conditions.

“Is a short-term fix always beneficial?”

Typically, borrowers might consider short-term fixes to take advantage of lower rates without committing for an extended period, thus retaining flexibility in a fluctuating market.

However, the decision to opt for a shorter fix, such as one or two years, should be aligned with accurate rate forecasts.

For example, if rates are expected to drop significantly within the next 18 months as predicted by economic analysts, a two-year fixed rate might shield you from higher variable rates in the short term while still allowing you to benefit from lower rates once the fixed period ends.

Banks often set the pricing of their fixed rates based on their forecasts, which means the most attractive rates might actually appear for two or three-year terms if they predict rates will fall thereafter.

Case study: The real cost of waiting

Let’s compare two situations: one where a borrower fixes a rate on a $600k loan immediately, and another where they wait, hoping for a decrease in variable rates as predicted by economic forecasts.

Scenario 1: Fixing the rate now

• Fixed rate: 5.89% for two years.
• Total interest paid over two years: Assuming the rate remains constant, the interest paid would be approximately $70,680.

Scenario 2: Staying with a variable rate

• Current variable rate: 6.2%.
• Projected rate after 18 Months: Decrease to 5.0% based on economic forecasts.
  • Interest cost in the first 18 months: Approximately $55,800.
  • Interest cost for the remaining 6 months: Assuming the rate decreases to 5.0%, the interest paid would be about $7,500.
• Total interest paid over two years: Approximately $63,300.

In this case study, by waiting, the borrower might save around $7,380 over two years, based on the forecasted rate reductions. However, this decision carries risks, such as the possibility that rates do not decrease as predicted, potentially increasing the total cost.

For example, the CBA has recently predicted there may be 5 rate reductions of .25% each spread evenly between December and next December (this article also explains this).

However, there are some lenders currently offering a fixed rate of 5.39% for two years, which is only a difference of $1,380 over a two-year period. So, it’s close.

Need help choosing between fixed or variable? 

We get it. This is a big decision, and there’s lots to think about. That’s why we offer our Free 30-Minute Finance Strategy Session, where you will:

• Get a better understanding of the interest rate options available to you, and the pros and cons of your choices.
• Get an up-to-date picture of the lending landscape including rates, conditions, and how to structure loans.
• Discover ways to save money on interest, fees, and charges that are specific to your unique situation.
• And more.

This no-obligation free session will be held with one of our experienced mortgage brokers.

Please be assured this will not be a thinly disguised sales presentation. On the contrary, you’ll receive our best strategic advice, specific to your situation, so you too can accumulate multiple properties without sacrificing your current lifestyle and accelerate your progress towards wealth.

Schedule Your FREE 30-Minute Finance Strategy Session Today

———

Please note, the numbers and assumptions listed in this article are for educational purposes only. Individuals should seek specific advice pertaining to their unique situation and the real estate market before making any decisions.

Trilogy Funding Two is a corporate credit representative (Representative Number 506131) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237)