Fixed rate Loans...Yes or No?
The decision by the Reserve Bank Australia to cut the official cash rate this month confirms we are still experiencing the best interest rates in a generation at just 1.50%!!
Off the back of this, we have had plenty of enquiries regarding fixed rate loans between 3-5 years.
‘To fix or not to fix?’
We touched on this subject briefly back in April 2012 when 3 year fixed rates were around 5.99% and the Reserve Bank cash rate was 4.25%. Since then, the cash rate dropped to 3.75% in May and down to 3.50% in June of that same year and the media was screaming this was a bad thing. Now it’s simply not low enough at 1.50% according to some media factions! Can’t seem to please them…
The decision to fix part of your loan depends totally on your financial strategy, cash flow position and what your plans or intentions are for the fixed period.
Fixing the interest on your home loan simply because the minimum repayments are going to be cheaper during the fixed period is the wrong reason to fix! If you feel you need to do this, then it will only provide a ‘band aid’ solution to a possible greater issue within your financial realm that should be addressed. Whereas fixing the interest as a strategy to reduce your overall debt whilst maximising your interest cost savings is a sound reason to do so.
As an example;
We recently worked with a borrower that was advised by their local bank branch to fix their home loan for 3 years and make it interest only as the repayments would be cheaper and would free up cash to allow for spending in other areas. When the fixed period expired, the repayments reverted to both principle and interest (P&I) and increased considerably. Subsequently, the lender declined their request to remain on interest only payments simply because this was not reducing the debt and was correctly considered by the bank as not complying with responsible lending practice. The borrowers now had the same amount of debt they started with, and even more challenging, they had higher monthly repayments and the overall period to pay off the loan had been reduced from the original loan term of 30 years to just 27 years (less 3 years).
Putting some numbers around this scenario:
A 30 year loan of $450,000 @ 4.5% interest only is about $1687.50 per month, which provides short term relief, but then reverts to P&I over 27 years which is $2401.63 per month - a considerable hike in repayments of close to $750 per month. As opposed to having monthly repayments of just $2280 if P&I terms were maintained on the loan from the beginning.
When the borrower initially set up the loan, a very effective and responsible plan would have been to split the loan facility, making it part fixed and part variable. In this case, arranging for the fixed portion to be interest only to minimise interest cost, whilst keeping the variable portion P&I and making extra repayments on the variable split every month or when possible to reduce the overall home loan balance over the fixed term.
The net result after 3 years would be a significant reduction on the variable portion, meaning the whole loan amount would potentially be reduced by tens of thousands of dollars over that fixed 3 year period; savings of approx. $28,600 at current rates in the case of our example above and major savings in interest going forward!
Smart people use this type of strategy to help pay off their home loan with minimal stress.
We can help clarify any questions related to fixed or splitting loans for your own situation.
Please call me on 0438 041 111 for a confidential discussion about how much money we may be able to save on your home loan.
As always, enjoy life, work hard, play safe and remember that we are always here to help you
‘Take the Confusion Out of Lending’
Peter Vinci - 0438 041 111