Interest Rates – To Fix Or Not To Fix. . . that is the question!
I was reading an article last week about folks who have fixed their mortgage interest rates AND suffered the consequences. It reminded me just how significant, perplexing and urgent a decision it is. . . to fix OR not to fix.
Before I launch into a discussion about this extremely important topic, I issue one caveat: almost everyone has an opinion and what follows is my opinion based on personal experiences – my own AND those of my clients. Ultimately you will need to make your own decision. You should seek the advice of your professional advisors prior to making your decision.
Notwithstanding this discussion is based around personal opinion, there is a good deal of anecdotal evidence to support my proposition.
OK, now that’s out of the way, let me answer the question: ‘should you consider fixing your mortgage interest rate or not?’
My definitive response to that question is NO! Let me explain why. I call this. . .
‘5 Reasons Not To Fix Interest Rates’ –
Reason #1: How do you know where the cycle is at?
Like most elements of the economic equation, interest rates run in cycles – they go up and they go down. In fact when you graph interest rates over time, they appear like a ‘bell-shaped’ curve with ‘peaks’ and ‘troughs’.
If the standard variable interest rate is currently at (say) 5.6%, are rates at a peak, a trough OR somewhere in between? In my experience, in order to get it right, you either (i) need to be brilliant (having completed your calculations, graphs, etc and come up with the right outcomes in terms of where the interest rate cycle is at) OR (ii) need to have ‘lady luck’ (in copious quantities) on your side. Well let me tell you, neither occurs very often so probability is definitely on the lender’s side.
Reason #2: How do you know what’s likely to occur in the future?
If you are able to predict the future, please give me a call – I have a business proposition for you.
If you have had any experience investing in or trading the share market, commentators often talk about the difference between predicting the future and the probability of something occurring in the future. It is impossible to predict the future . . . at best we can only attempt to calculate the likelihood (probability) that something will occur. I don’t know about you BUT I have little confidence when attempting to ‘guesstimate’ where rates are likely to end up. Anyway, generally speaking, fixed interest rates tend to factor in rate increases well in advance, so by the time you decide to fix, it’s probably too late anyway.
Reason #3: Do you really want your banker to control what you do?
Imagine you want to buy your first (or another) investment property and your existing lender (with whom you have a fixed interest rate loan), will not ‘come to the party’ with the necessary funds. You decide to change lenders – to one that will lend you the money required. You approach your current lender for a payout figure on your existing (fixed interest) loan and are informed that in addition to paying back the mortgage balance, you are up for break costs of an additional (say) $30,000 (I’ve used $30,000 only as an example based on recent anecdotal evidence – break costs will vary based on the circumstances of each individual loan BUT they usually are significant).
You now have a decision to make. . . break the loan and incur the significant costs OR not. If you decide not to break the loan, there is a strong possibility you may not be able to buy that investment property. In other words, your lender is in control.
Reason #4: How much will it cost you in ‘break costs’?
A common response to this question is. . . ‘BUT I wont need to get out of the mortgage contract and therefore I wont be affected’. I cannot calculate the number of folks who have said this to me only to find that some time during the fixed rate period, they either want to OR need to exit the fixed rate loan contract.
Most folks seem to think that circumstances will never change and that even if they would prefer to exit the contract, they will hang on to the end (and therefore not incur break costs). What they fail to consider is that individual circumstances do change – could be employment, health, family or a variety of other reasons. In other words, based on changing circumstances, you may not have a choice.
Reason #5: How much will it cost you in the mean time?
With most folks there is usually a ‘time-gap’ between the level variable rates are at AND when they make a decision to fix. An example will help to demonstrate:
Imagine the standard variable mortgage interest rate is currently 5.6% while a comparable (in terms of features) 5 year fixed rate loan is 7.5%. That means your variable interest rate will need to increase by almost 2.0% (7.5% – 5.6%) before you start gaining any benefit. At this point you need to ask yourself two questions: (i) are interest rates likely to increase by 2.0%+ over the next 5 years? AND (ii) even if they do (increase by 2.0%+), when will they increase? Normally rates increase gradually, so if you were to fix your rate at 7.5% right now, you will have to wait until variable rates increase by more than 2.0% before it stops costing you money.
Well there you have it. In my opinion, no-one should ever fix interest rates because the balance of probabilities (the likelihood of guessing right) is definitely in the lender’s favour. I don’t know about you BUT the one thing that really ‘urks’ me is lenders having more control over my investments than me. After all, isn’t the purpose of education and experience to control your own destiny. . . no-one cares more about your money than you.
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Tags: fixed v variable interest rates, interest rates, investment property
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