To fix or not to fix? That is the question.
The national property market is cooling, somewhat, and both Labor and the Coalition are offering up ways to make it easier for first-home buyers to turn the key on a new property.
Prior to the election, home ownership for low-and-middle income earners — without the bank of mum and dad — was little more than a pipedream, but both sides of politics are now dangling the carrot of the Great Australian Dream.
Both major parties have outlined what you’ll need to earn, the size of the deposit you’ll have to stump up, and what your regular monthly repayments will look like.
Labor will back the Coalition’s housing policy if the Liberal National Party wins government too, so either way the deposit many Australians will be required to stump up is about to fall.
But no-one can tell you whether to go with a fixed or a variable rate loan in the process.
So, what’s the answer?
Six of one and half a dozen of another
An extraordinary number of borrowers freaked out about the future of their finance when the pandemic hit in early 2020.
As a result, a huge amount of property buyers have taken out fixed-rate loans over the past couple of years.
In fact, it’s exploded from roughly 15 per cent, to 50 per cent of all new lending.
But that will shift as the average fixed rate and the average variable rate converge.
And that’s the crucial point here.
During the onset of the pandemic it was in the banks’ and the borrowers’ interest to lock in a cost of financing, and the banks obliged by making their fixed-rate home loan products competitive.
Recently, as the cost of sourcing fixed-rate loans has increased for the banks (as offshore interest rates rise), and the cost of sourcing short-term finance (for variable-rate loans) remains very low, banks have been encouraging customers into variable-rate loan products instead.
That cost for the banks of obtaining short-term finance (which they use for variable-rate loans) is about to increase.
“We do expect fixed and variable rates to slowly look similar over the coming years, because the reason fixed rates were so low compared to variable rates in 2020/2021 was because of Reserve Bank stimulus,” ANZ Research economist Adelaide Timbrell says.
“That’s now over and the Reserve Bank has started its tightening.
“We’re not likely to see such a huge gap [for a long period of time].”
Variable vs fixed payments
One way to measure the difference is to crunch the numbers on a typical loan, in terms of monthly mortgage repayments.
Let’s look at fixed rates first.
For example, if someone with a $500,000 loan, paying principal and interest fixed mid-last year at 1.92 per cent for two years (the big four bank average two-year rate at that point) they would be currently paying $2,099 in monthly repayments.
When their fixed rate ends in June 2023, they would be looking at a revert rate of approximately 5.33 per cent (based on RateCity’s estimate of where the Reserve Bank’s cash rate will be next year).
That means monthly repayments would rise to $2,947 — an increase of $847 a month.
“Anyone who locked in a fixed rate over the last couple of years has temporarily bought themselves some immunity to the upcoming rate hikes,” RateCity Research Director Sally Tindall says.
“[But] revert rates are often significantly higher than what banks offer new customers.
“When they signed up for the fixed-rate loan at the start of the pandemic the revert rate would have looked more like 3.43 per cent, so many people will be in for an almighty shock because [variable] rates are likely to have more than doubled.”
That’s if they just accept the bank’s revert rate, instead of rolling over into another fixed-rate deal or shopping around for a better variable rate.
So what will happen to variable rates?
If the Reserve Bank lifts the cash rate target by 0.15 percentage points today (assuming that move lifts the actual cash rate as well), the average owner-occupier with a $500,000 debt and 25 years remaining will see their repayments rise by $39 a month.
If the RBA hikes by 0.40 percentage points, as some economists are predicting, their repayments will rise by $104 a month.
Westpac is predicting the cash rate will rise eight times by next May, taking it to 2 per cent.
If this happens, the same borrower could see their monthly repayments rise by $511 a month on a variable loan.
Interest rate rises are likely to continue well into next year. And the rates for new fixed-rate loans have already been climbing.
So the cost of variable rate loans is about to rise. Fixed-rate loans may also rise too, but perhaps the difference will not be as notable. It depends on how much inflation pressure build in both the United States and overseas more broadly.
It’s important to remember that by taking out a fixed-rate loan, you’ll need to cough up extra cash if you refinance your loan at any stage, move home or break the contract for another reason.
On a loan of hundreds of thousands of dollars, the break fee can be upwards of $15,000.
The bottom line is that fixing a home loan offers you some peace of mind for a time, but there are restrictions in what you can do – including making extra repayments.
On the other hand, variable rates are lower and more flexible but are about to rise, potentially quite significantly.
The answer as to whether to go with a fixed or variable rate loans rests with the borrower, but in terms of the cost of each option, over time, analysts agree they’re moving closer to one another — they’re converging.
The pandemic muddied the waters for so much that we do in life, but it did make the decision on whether or not to fix a loan relatively simple.
Although you could argue as the cost of the two options move closer together, the decision becomes easier — maybe.
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