Time to consider fixed loans again

 

Author: Matthew Bell
Publication: Economist,, Fairfax Digital Australia and New Zealand Pty Ltd.

Time to consider fixed loans again

The RBA has now raised interest rates in six of the last seven monthly meetings. The standard variable mortgage rate is now nearly 1.6%p.a higher than where it was when the tightening phase began in early October last year. According to Cannex, the average standard variable home loan rate is currently 7%p.a.

In fact, the rises in rates over the last 6 months have exceeded all previous forecasts. This is because most economic data during that period surprised everyone with unexpectedly good results. We have had unemployment fall and company results improve quicker than expected. Not only that, house price growth remained very robust in the first quarter of 2010, even in the face of the rate rises of late 2009 and the consequent fall in demand for home loans.

Notwithstanding the wobbles in world share markets and some European economies of the last few months, the economic outlook for Australia still looks relatively strong. Most economic forecasts of interest rates are for another 0.5%p.a to 0.75%p.a by the end of 2010, and then for continuing rises until we get to a cash rate closer to 6%p.a by the end of 2011. This would put the standard variable rate at close to 8.5%p.a.

In March, the proportion of owner-occupiers taking out fixed rate home loans was 2.1%p.a, the second lowest proportion in the nearly 20-year history. Is it time though to reconsider the fixed rate home loan?

The average 3-year fixed rate offered by the major banks is about 7.75%p.a. If we take an example of two new home-buyers taking out a $400,000 thirty-year mortgage. One locks in their fixed rate of 7.75%p.a for 3 years, while the other remains on the variable rate over the same period. Who is better off at the end of the 3-year period?

Assume that mortgage rates travel the expected RBA path discussed above, and rise to reach 8.5%p.a by the end of 2011, half way through the available 3-year fixed term, and remain there until the end.

Under that scenario, at the end of 3 years, the borrower on the fixed-rate loan will have paid off $640 more principal, but will have paid nearly $4,000 less in interest. This might seem large, but in the context of well over $100,000 in total payments, the difference is not huge.

The point to make is that going by the current likely paths of variable interest rates and the current level of fixed rates, there is not much between the two strategies. Certainly, not enough to justify only 98% of all new owner-occupier loans being variable. 

  Top of page  Other articles