Consider the potential for the cash rate to fall before settling on a fixed-rate loan. Picture: Louise Kennerley. Consider the potential for the cash rate to fall before settling on a fixed-rate loan. Picture: Louise Kennerley.
A fixed-interest loan could be a burden if rates are cut amid the latest economic unrest.
If interest rates fall significantly as a result of the turmoil on world sharemarkets, home buyers who have a variable-rate loan will be a lot better off.
But if you've recently signed up for a fixed-rate mortgage, you could have a problem on your hands.
It's important to take extreme care with fixed-rate borrowing. This is especially so when the interest rate outlook is uncertain.
Until 10 days ago, most commentators had been tipping that the Reserve Bank would lift the cash rate by between 0.25 and 0.75 points before Christmas. That's now history.
Experts are instead predicting either no change to the cash rate, which is now at 4.75 per cent, or a rate cut as high as 0.75 points in the next few months.
There's a lesson in this for borrowers. The crisis in confidence in the global economy highlights the need to always consider the potential for rates to suddenly move up or down.
A fixed interest rate on part or all of a home loan gives some insurance against rate rises but can badly burn borrowers if rates drop by a big margin.
Fixed-rate loans also have very different terms and conditions to variable-rate loans (see Fast facts). These kinds of loans provide budgeting peace of mind, though, and have become more popular since last year's four consecutive interest-rate rises.
Mortgage broker AFG publishes a mortgage index showing that the proportion of fixed-rate loans surged from 2 per cent of the total it handled in January last year to 12.6 per cent in December. Fixed-rate mortgages accounted for 8 per cent of all mortgages facilitated by the group last month.
The general manager of sales at AFG, Mark Hewitt, says rising consumer concern about the future of interest rates has made fixed-rate borrowing attractive. ''Most Australians are still fearful about their financial future,'' he says.
Another broker, Mortgage Choice, says new borrowers taking out fixed-rate loans accounted for 13.3 per cent of its approvals in July.
But a spokeswoman for the group, Kristy Sheppard, says home loans in which the interest rate is discounted for the entire loan term, usually in return for an annual fee, are increasingly challenging fixed-rate loans for market share.
One, two or three-year fixed rates are now at about the same level (or less than) as variable rates offered by many lenders. So by opting for a fixed rate, you can only really lose if rates tumble and stay down.
This does happen, however. In the mid-1990s, borrowers with long-term fixed-rate deals were paying 11 per cent or 12 per cent for their money, while those on variable rates had an interest bill of only 8 per cent.
Ms Sheppard says some borrowers are moving away from less flexible loans.
''With the cash rate on hold for the longest period since November 2006 to August 2007, this month we may see a reduction in appetite for fixed-rate loans and growing hunger for discount-rate home loans,'' she says.
Fast facts
  • Most fixed-rate loans are inflexible. You cannot vary the amount you pay back each month and there is no redraw facility and no offset.
  • To counterbalance the problems that arise from this inflexibility, it's a smart move to negotiate a split loan. Your lender or mortgage broker should be able to provide a loan that's part variable and part fixed.
  • The fixed portion of the loan gives you ''insurance'' to offset future interest-rate rises. At the same time, you can make extra payments into the variable portion to shorten the term of this part of the loan.
  • Source: The Age