TO FIX OR NOT TO FIX ?

How to ease the pain of rate rises
February 20, 2005
The Sun-Herald

Interest rates may be on the way up, but for once the horse doesn’t seem to have bolted for home loan borrowers.

Usually the money markets are way ahead of the pack when it comes to interest rate rises and quickly factor them into the cost of fixed-rate home loans so that by the time borrowers actually focus on the problem there is no real advantage in switching.

But this time around the financiers seem to be a little slower and some fixed-rate home loans still have lower rates than variable loans. So quick borrowers can lock in an advantage, but you don’t have a second to lose, because 15 lenders have already moved to rectify the situation and the others will soon follow.

An interest rate rise of a quarter of a percentage point is tipped for next month, which would increase the monthly cost of a loan by $32.15 for a borrower with a $200,000 mortgage and assuming a borrower’s interest rate rises from the average standard variable rate of 7.07 per cent to 7.32 per cent.

The average home loan in NSW was $263,000 as of last December. It was above $400,000 in Sydney. The worry is the rate rises will continue with many predicting another quarter percentage point in April and another a few months later.

Some economists think this cycle will result in rates going up by 2 percentage points before they stop.

By itself, this doesn’t seem like much. But think about it. If your variable home loan is 7 per cent at the moment, that rise on top is a whopping 30 per cent increase in monthly repayments. Do the sums.

While the average standard variable is 7.07 per cent, the average rate for a three-year fixed-rate loan is 6.7 per cent, and it’s 6.74 per cent for one year. The financial nerds call it an “inverse yield curve”, which is mumbo jumbo for the fact that rates now are higher than those in the future. Usually it’s the opposite way round, which is the premium imposed for having a longer term loan.

So look at your finances and determine the impact of a worst-case 2 percentage points rise in your home loan rate and the impact it will have on the household budget.

If it looks like being a squeeze, start to take action now and maybe lock in at least part of your home loan.

Many borrowers have a bet each way, fixing half their home loan and leaving the rest variable. This gives them some protection against any rate rise while leaving them the ability to get ahead by paying down the variable portion faster if they can afford to.

But make sure you talk to your financier to establish what is best for you.

Not all fixed-rate loans are the same and they can come with a few nasty surprises. It’s all about educating yourself.