Should I fix long or short term (or float!) in the current market?
Age-old questions: How long should I fix my interest rate for? And how do I decide what interest rate strategy is most appropriate for my circumstances?
There are many variables to consider when in deciding on a fixed rate and equally many different circumstances to consider. In the absence of a trusted adviser, it can be quite the dilemma pondering which fixed interest rate(s) to choose, or even to float, especially knowing that interest rates are currently in a depreciating cycle and OCR and inflation peaks have been and gone.
In the current market, we are observing interest rates at the main banks between 6.79% for 6 months, 6.19% for 1 year, and 5.59% for 5 years. However, just because the five-year fixed rate is 1.2% cheaper, doesn’t necessarily mean this is the most financially advantageous move to make, nor if it makes sense for your personal circumstances.
For example, you may wish to sell a property in 2 years, and interest rates could decrease considerably, leaving you susceptible to break costs that can be notoriously expensive.
There are also enticing offers like a recent one of 5.99% for 6 months or 5.59% for 12 months starting on September 12, 2024. At first glance, it seems like a no-brainer to refinance at this rate. However, as the saying goes, "there is no free lunch" or "the grass is never greener." In the fine print, this offer excludes investment properties and is not available to existing clients. Additionally, there are inevitable long wait times to implement the offer, and it explicitly excludes certain clients who might otherwise think they are eligible without further investigation.
From prior experience, the actual time cost of investigating such outlier promotions or one-off offers can negate any potential savings, assuming you even get approval and make progress.
It brings us back to how do we make sense of all the noise to work through what’s right for you and your mortgage strategy?
We like to talk numbers but not get too carried away!
In basic numbers the annual interest cost of a $1M home loan fixed for 1 year at present is c$61.9K per annum and on the 5 year rate is $55.9K. So why don’t you just jump onto 5 years fixed right now and save $6K per annum?
It’s all to do with future rate movements.
For example, if the 1 year fixed rates move to 3% in year 2 of your 5 year fixed loan at 5.59%, you’re losing $25.9K additional interest for every year the 1 year fixed remains at 3%, whilst you complete the 5 year commitment made! If it stays at 3% for the remaining 4 years that’s $103.6K down the drain! So, suddenly, the $6K savings in the first year doesn’t look too enticing.
This is a somewhat extreme example but it illustrates the principle of interest rate movement risk. In year two of the five year fixed example, the rate only has to move to 4.99% to wipe out your initial $6K of savings, and will cost you $18K in the long run if the average 1 year rate remains at 4.99% (accounting for the zero sum of the first two years).
Sounds strange to have a rate as low as 4.99% as of September 2024 but it was not that long ago when 4.99% was at a premium (think 3 years prior 2% rates).
There’s always the exception, as some individuals do not mind paying for insurance or certainty of repayments over 5 years which is a unique decision and, in some instances, preferable to pay for certainty.
For example, a nominal loan balance with 5 years remaining on the mortgage and you want to ensure full repayment within the 5 years whilst your budget supports comfortably. This is a sound example of a 5 year rate being advantageous as you are certain the repayments you make over 5 years will conclude your mortgage.
So how do I compare two rates?
Think averages. Or what is the interest rate that a rate would need to increase or decrease to that averages the rate I’m considering fixing for if purely driven by price?
For example, consider the 1 year and 2 year fixed rates being 6.19% and 5.69% respectively at present. If considering fixing for 2 years at 5.69%, what would the alternative 1 year rate need to decrease to after the first year at 6.19% to make it worthwhile to fix for 2 years today?
If you are of the view that the one-year rate will not decrease below 5.19% after the first year on 6.19%, then you fix for 2yrs as you are saving money fixing for two years if you are correct
If you are of the view that the one-year rate will decrease below 5.19% after the first year on 6.19%, then you fix for 1yr as you are savings money fixing for 1yr if you are correct
If that’s a bit confusing, not to worry. We have tools which do all the heavy lifting for you so you can compare across all interest rate terms to formulate some objective analysis and make informed decisions. We’ve got you covered and can discuss further in person all else fails!
How about floating?
Floating is the same principal as deciding between two fixed loans and the average rate that you are hoping for the future fixed rate (or future floating) to decrease to recover your costs up front of leaving your loans on floating whilst awaiting rates to decrease.
There may be other reasons to remain on floating outside purely price (such as negotiating a retention package with your bank and entertaining a competing bank offer - but that’s a different story for another day).
You also have more flexibility in making penalty free lump sum payments which is another option if you have savings or inheritance imminent to credit your loan with a lump sum payment which can also save time (see our time savings calculator).
In general, at present the cost of being on floating is not more financially advantageous than re-fixing immediately given the more gradual decrease in fixed lending.
Do we have a crystal ball?
I’d love to say yes but in reality, no one knows future interest rate movements - if they tell you they do, run!.
You can make educated guesses and form your opinions by reading economic commentary, listening to expert analysis, and studying the consensus. All these elements can help shape your perspective. However, it's important to remember that no one can predict the future of interest rates with complete certainty. Ultimately, the decision on how you think interest rates will move and how to strategise accordingly is entirely up to you.
In summary
Interest rate requirements vary for everyone, and the decision to choose one rate over another, or whether to stay with a variable rate, isn't always based solely on cost. Each rate option comes with its own set of advantages and disadvantages. What's crucial is to carefully review your lending options and, at the very least, consult with a Financial Adviser. A quick 10-minute discussion could save you thousands.
At Hawkeye Finance, we provide summary tools and market intelligence to help you make the most advantageous decision based on your current circumstances, which can change frequently.
While no one can predict the future of interest rates, you can develop informed views and choose the best rate to lock in, considering averages and some objective thinking. Ultimately, there's no right or wrong answer. If you've taken the time to consider every angle before committing to any rate, you are already winning.
Fine print
Disclaimer: This article is not financial advice. It is informational only and should not be considered as formal financial or legal advice. For formal advice based on your unique circumstances please speak to us directly.