Better never than late

The problem with changing from a variable rate home loan to a fixed rate loan is that by the time it seems like a good idea, the horse has probably already bolted. Locking in a fixed rate at the top end of the interest rate cycle is worse than doing nothing.

We converted around half of our home mortgage balance (home and investment rental property) into a five-year fixed rate loan a little under two years ago. At that time rates in Australia had already bottomed out and there had been a couple of 0.25% increases in the variable interest rate. But fixed rates were still lower than variable as a lot of commentators were expecting rates to top out and start dropping again fairly soon. Most home loans in Australia are taken as variable rate loans (similar to US ARMs), and at that time not many homeowners were choosing to move to fixed rate loans.

Two years later and our fixed rate loan is looking pretty sweet after a string of four 0.25% rate rises by the reserve bank in the past year, plus an extra 0.2%-0.3% increase in home loan rates added by the Australian banks due to the increased cost of funds caused by the global credit crunch. Recent figures show that fixed rate mortgages are becoming more and more popular, as home owners get concerned about the prospect of further rate rises.

But is this a good time to be choosing a fixed rate loan? While a fixed rate eliminates the risk of increased loan payments in the future, it also locks in the rate rises of the past two years. If variable home loan rates drop substantially in a year or two, getting out of a five-year fixed rate loan would be very expensive. Although no-one has a particularly good track record at predicting future interest rate movements, the fact that longer term fixed rate loans are available for lower rates than the current variable rate loans suggests that future rate movements are more likely to be down than up.

For example, for a home loan St George bank is currently advertising:

Variable rate....9.37%
1-year fixed.....9.05%
3-year fixed.....8.95%
5-year fixed.....8.90%

and similarly, a margin loan rates from a couple of lenders are:

1-year fixed.....9.8%
2-year fixed.....9.7%
3-year fixed.....9.6%

For the three and five year fixed rates to be 0.2% lower than the current standard variable rate (when most pundits think there's a good chance of one more 0.25% rate rise by the RBA in the next few months) suggests that the banks and other lenders expect interest rates to have dropped by around 0.5% over the next couple of years.

I won't be rushing out to fix the variable rate part of our home loans at this time, but it may be a good time to rollover our current fixed rate loan when it matures in another three years.

Copyright Enough Wealth 2007