To Fix or Not to Fix my Interest Rate

On Melbourne Cup Day, 4th November 2008, the Reserve Bank of Australia reduced the official cash rate from 6.00% to 5.25% which is a 75 basis points decrease. With the ever growing concern about what is going to happen tomorrow, borrowers should start to ask the question if fixing their interest rate now is worth doing or wait for further interest rate drops.

I have been hearing in the news about doom and gloom scenarios, about companies restructuring under the current economic pressures, investigation of companies and their board, share prices going down, super funds not allowing withdrawals (especially funds linked to mortgage funds) and job losses. These sort of reports from the media do not really give confidence that there is light at the end of the tunnel. However I am sure that there is indeed light at the end of the tunnel, it is just a little dim right now. To quote an ancient proverb, "To everything there is a season, A time for every purpose under heaven".

A number of my clients have asked me the question, should they fix their interest rates on their home loans or leave it as variable. Hence the topic, "To fix or not to fix". Well, the answer is not that simple and you the borrower will need to evaluate your current situation, and lifestyle.

You might ask, what has my current lifestyle got to do with fixing the rate? Simple. Do you have a budget? If so, are you sticking to it? Have you been able to stick to it? If your answers are Yes, then keeping the rate type as variable and riding the interest wave should not affect you. However if you had answered No to one or more of the questions above, then you might want to consider the security of fixing your interest rate, IE knowing how much you need to pay your loan every month.

The above is simply "living within your means". I have noticed that clients who keep to a budget also have goals. They are driven by the same set rules to minimise their loans or get it under control as soon as possible. This drive has earned them "reward points" or "reward dollars", like the ability to redraw from their current loan or to utilise their savings to purchase another property. The power of reducing your mortgage is the ability to budget well and be disciplined at it.

So what has this to do with variable or fixed rates you might ask. Well let's just explore this. In good times, do we save? or do we spend? If we start with an income of say $50,000 per annum, we would generally spend up to (hopefully) $50,000 and not more. So what happens when our income increases to $60,000 per annum? Do we spend just $50,000 and save the $10,000 or do we now spend $60,000?

Again, it is relatively simple. Are you living within your means? Have you a safety net in the event that you might need to live off your savings for a while? Everyone is different and understanding where you are at right now might provide you with the answer of fixing or not.

Ok so let's talk about lifestyle. Now everyone has their own "style". There is no right or wrong to this but you will need to balance this out with income and expenses. Income is the money that you earn, whether it is a business or salary, rental or interest, they are all income. Expenses are all the cost that is associated with living, for example food, entertainment, insurance, motor vehicle running costs, going to work every day, all monies going out are known as expenses. So the question of lifestyle is simple, where is your money being spent? Are you saving enough, are you paying off your debts (and not increasing them) and are you living well?

I have heard some people call it the 1/3, 1/3, 1/3 rule. 1/3 is utilised for living expenses, 1/3 is used for savings, and the final 1/3 is used for paying off debts. Where are you in regards to this? Also in good times, some of us will have spouses who can help reduce the mortgage quicker. Are you using this additional income to pay off the mortgage or are you spending this additional income because you can, because it is there?

Hence it is very important to know where we are at with our lives and are we living within our means. Things that need to be considered would be:

1. what if my income were reduced
2. what if I lose my job
3. what if my spouse stops working
4. what if interest rate increases
5. the same question could be asked, if interest rate were to decrease

The above are just a few questions that we need to ask of ourselves. Are we prepared for it?

There are some disadvantages in fixing your interest rates. Here are just some of them:

1. in a market whereby interest rates are falling, locking the interest rate might see you pay more in interest.
2. when you want to get out of your loan for whatever reason, for example whether you would like to sell your property or just refinance your loan, if you are in a fixed rate period, there might be penalties imposed on the loan.
3. if you need additional funds and you managed to deposit the additional funds into your fixed rate loan, you might not be able to redraw the additional funds.
4. some lenders will not allow you to deposit more funds into your loan without charging you a fee for doing so.

The best person that can decide if it is better to fix or not to fix the interest rate would be yourself. Your mortgage broker will be able to help you explore and weigh out advantages and disadvantages in fixing your interest rate.