When interest rates are on the rise, is it a good time to lock your borrowings in with a fixed interest term?
The statistics tell us that the borrower loses more than 80% of the time from choosing to fix rates, rather than staying with a variable rate. This can be from moving too early, or more often too late in the rate changing cycle. It is also because financiers factor in the risk they are taking into their fixed rate offers.
Think strategy, not timing the market
Fixing interest rates may or may not be a part of your strategy depending on your longer term plans and objectives. Fixing the interest rate on loans can provide certainty for cash flow but there are also risks.
For many finance advisers the discussion centres purely around creating predictable cash flow scenarios, such as: "How will it impact your budget if interest rates increase by 1-2%?". This is a common consideration for residential mortgage holders, which could be adopted more often in commercial lending.
A conversation on fixed interest rates should primarily focus on:
- Whether there will be material changes to the loan during the fixed term, such as extra repayments, discharge fees, etc.
- The pure and simple maths - do you want to take a risk on being one of the clever (or lucky) 20% and how will it affect you if you are one of the 80% instead?
The benefit of hindsight
So what else does history tell us?
Take the popular 3 Year P&I Fixed Rate Loan for Owner Occupied Home Loans. If we look at all 3 Year Fixed Rates up to September 2018 - and roll forward to compare it with the average discounted variable rate over that period, the variable is the winner.
Over recent history, the variable option has always been the better one. Our analysis goes back a lot further, to show that there have been only four clusters of months were fixing was a good option. For example, we expect that in hindsight, the early 2020 cycle will be shown in the future to have been a great time to fix rates.
Factors such as approaching the bottom of an easing cycle will see the gap between fixed and variable narrow significantly. There is also the reality of lenders providing better interest rates for new loans than existing loans.
So, to fix or not?
Monetary policy (as set by the Reserve Bank of Australia) may be less relevant but it is still the main driver of variable interest rates. It is always difficult to anticipate what the future will hold, especially as the RBA continues to focus on reducing inflation in today's climate.
Therefore, the best guide is the money markets as they are based on the free market which impacts fixed rates more readily. When market rate rise, it is no surprise that fixed interest rates drop.
When a customer asks about the value of a 3-year fixed rate term, the answer is to consider the opportunity cost of the variable rate. In other words, will the variable rate spend more time below the current fixed rate over the 3 years? Remembering that the client will be say 30 basis points (0.50%) ahead from day one of the term by not taking the fixed rate offer.
For accurate lender rates and support for approaching these decisions please contact us.
Contact MCP
1300 510 816 or your Finance Partner
enquiry@mcpfinancial.com.au