With fixed interest rates on the rise, is now a good time to lock your borrowings in?
The statistics tell us that the borrower loses most of the time (more than 80%). This can be from moving too early, or more often too late in the rate changing cycle. It is also because financiers need to win because of the risk they are taking too.
Think Strategy, not timing the Market
In understanding longer term plan and objectives, fixing interest rates may or may not be a part of your strategy.
Fixing the interest rate on loans can provide certainty for cash flow but there are risks too. A key consideration is the period of time that they see opportunity or risk.
In the past, for many finance advisers the discussion used to be centred around scenarios. "How will it impact you in interest rates increase by 2%?". With the more granular review of cash flows now, this is usually a more widely understood commodity before getting to this point.
For commercial lending, a lead could be taken from mortgages where the conversation around this topic doesn't happen enough.
The conversation on fixing should primarily focus on:
- Whether there will be material changes to the loan during the fixed term considered (Extra Repayments, Discharge etc.)
- The pure and simple maths, do you want to play fixed and be one of the clever or lucky 20%?
Looking in Hindsight
So what else does history tell us?
Take the popular 3 Year P&I Fixed Rate Loan for Owner Occupied Home Loans. We can 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.
Over recent history, the variable option has always been the better one. Our analysis goes back a lot further, and there have been four predominately clusters of months were fixing was a good option.
The gap has narrowed significantly though, and this is not unexpected when approaching the bottom of an easing cycle.
We expect that in hindsight, the current cycle will be shown in the future to have been a great time to fix rates.
So, to fix or not?
Monetary policy (via the Reserve Bank) may be less relevant but it is still the main driver of variable interest rates. It is difficult to anticipate what the future will hold, especially as the RBA have been active in keeping interest rates low in the short term.
The best guide is the money markets as they are based on the free market and impact fixed rates more readily. So with market rates now rising, it is no surprise that fixed interest rates are so low at present.
So let's roll forward the table above. 3 Year Fixed Rates for example are around 2.90%, and a customer asks about its value. The answer is the opportunity cost of the variable rate. Remembering that the client will be say 30 basis points (0.50%) ahead day 1 by not taking the fixed rate offer, do you forecast that the variable rate will spend more time below 2.90% over the 3 year term?
As a sweeping comment, the fixed rate benefits would have appeared to have passed us by in this cycle.
For any support for approaching these decisions please contact us.