To Fix or Not to Fix?
As a rule, a fixed rate mortgage will usually cost you more than a variable rate mortgage. The flipside is that fixed rate mortgage offers certainty of repayments which is comforting when interest rates are rising.
In this article, we use Reserve Bank of Australia (RBA) data to go back through time and compare the cost of fixed and variable mortgages. We conclude that:
- 83% of the time borrowers would have been better off in basic variable rate products than 3 year fixed rate products.
- 96% of the time borrowers would have been better off with QuickDirect’s variable rate product when compared to traditional banks 3 year fixed rate products. This does not take into account the potential interest savings associated with the potential for early repayments and free redraw on the QuickDirect product. These features are generally not available on fixed rate mortgage products.
- Borrowers have not been particularly good at picking the best time to fix their rates with peaks in fixed rate approvals often occurring at the worst possible times. This could well reflect ‘scaremongering’ from the banks in the lead up to and around official interest rate rises.
The fact is that the odds of paying less interest in the future when you fix your mortgage rate are against you. To actually save money by taking out a fixed rate loan you either need to be better than average at predicting the future path of interest rates or just plain lucky.
With a background in financial markets, the author of this article knows only too well that highly paid professional economists have enough trouble predicting the future path of interest rates, so the rest of us really do need a lot of luck on our side to save money by taking out fixed rate loans.
So what’s the best option?
History tells us that over the long term, it’s usually cheaper to take out a variable rate loan. However, if you’re looking to lock in your payments then a variable option might be a bit scary for you.
Our recommendations would be:
Of course, there’s no right answer for everyone so you should do your research and consider your own situation. If you need a hand, our dedicated Customer Care Consultants are always available to help out with your mortgage enquiries.
How much buffer is enough?
Unfortunately there is no easy answer to this question. What we can say though is that over the last 20 years the most interest rates have risen is 2.75%. This was between 1994 and 1995. More recently, interest rates have risen 2.25% but this time over a much longer period – between 2001 and right now.
As a guide, if you’re taking out a variable rate loan we would therefore suggest you allow for a 2-3% interest rate rise in your budgeting. You can use our repayment calculators to assist with your budgeting.
If you’re taking out a fixed rate loan you probably don’t need to factor in such a significant buffer, but you do need to allow for the fact that when your fixed term expires your interest rate will change. The most 3 year fixed mortgage rates offered by the banks have increased over a 3 year period in the last 20 years is 1.25%. This was between 2003 and 2006.
As a guide, if you’re taking out a fixed rate loan we would therefore suggest you allow for a 1-2% interest rate rise in your budgeting. You can use our repayment calculators to assist with your budgeting.
Are fixed or variable rate loans a better deal?
In this article, we use Reserve Bank of Australia (RBA) data to go back through time and compare the cost of fixed and variable mortgages.
To do this, we take the total interest payable on the banks’ 3 year fixed rate and compare this to the interest that would have been payable on a basic variable rate loan over the same period. We do this for each month from September 1990 to July 2004 (the latest month for which three years subsequent data is available).
As an example, consider October 2000. This was a point in time when the big banks were heavily promoting fixed rate mortgages in the wake of the September 11 terrorist attacks. At the end of October 2000 according to the RBA, the banks average 3 year fixed rate ,mortgage would have cost you 6.30%. At the same time, a basic variable rate loan would have cost you 5.45% and a QuickDirect loan would have cost you 5.39% (had we been up and running).
Over the next 3 years, the 6.30% fixed rate loan would have cost you $47,250 in interest on a $250,000 interest only loan. Taking into account the actual path of interest rates, the basic variable rate loan would have cost you $43,260 and the QuickDirect loan $42,717 over the same period. In other words, customers would have been better off in the variable rate products.
We conducted this analysis every month from September 1990 (when data first became available) and July 2004 (three years ago). What we found was that in 83% of cases basic variable mortgages would have been cheaper than fixed rate bank mortgages and in 96% of cases the QuickDirect Variable mortgage would have been cheaper than bank fixed rate mortgages.
We then went on to examine the proportion of customers that chose fixed rate mortgages over time. Over time there is no real relationship between the proportion of borrowers taking out fixed rate loans and the associated costs. In other words, borrowers do not have a particularly good track record when it comes to picking the best time to take out a fixed rate loan. In fact, there have been times when borrowers tended to fix their loans at quite inopportune times.
