If there’s one decision that can stress you out as an investor, it’s whether to make your mortgage variable or fixed.
The problem is that you not only have to analyse the current market, you have to predict how the market will change during the fixed-rate period. With so many variables in play, even property and finance professionals can get it wrong.
Unfortunately, I can’t offer you a magic formula that will tell you whether or not to fix. But what I can do is lay out all the pros and cons to help you make an informed decision.
The pros of fixing your rate
Fixing your mortgage gives you certainty. It means you know exactly how much you have to repay each month. That, in turn, makes it easier to budget – which is particularly important in the early stages of your investment, when the property is most likely to be negatively geared.
Fixing looks even better if interest rates start rising after you’ve taken out the loan. The higher rates rise during that fixed-rate period, the more you save.
According to analysis of the approximately 4,000 home loans in the RateCity comparison engine, it’s currently cheaper to fix. Here are the current average interest rates for investors:
- Variable = 4.90 per cent
- 1-year fixed = 4.52 per cent
- 2-year fixed = 4.47 per cent
- 3-year fixed = 4.55 per cent
- 4-year fixed = 4.87 per cent
- 5-year fixed = 4.94 per cent
Anyone who fixed in November would be feeling good: since then, the average variable rate has increased from 4.56 per cent to 4.90 per cent.
That trend is likely to continue, for two reasons. First, the next move in the cash rate is likely to be up. Second, APRA is likely to further tighten the screws on investors.
Of course, things can change quickly, so neither of those events is guaranteed. That’s why you should always consult a professional before taking out a mortgage.
The cons of fixing your rate
Just as fixing can seem clever when rates are rising, it can seem foolish when rates are falling. The lower rates fall during that fixed-rate period, the more you lose.
That might seem irrelevant now, given that most experts think interest rates will keep rising. However, an unexpected domestic or international shock could change everything.
If you take out a fixed-rate loan, you’ll probably have to accept fewer features than with a variable loan (such as no offset or redraw). Also, many fixed-rate loans won’t allow you to make extra repayments.
Another problem with fixing is that you’ll have to pay a break fee if you want to close the loan early as part of a refinance.
Walking both sides of the street
If you’re finding it too hard to weigh up all these pros and cons, there is a third option – splitting your loan.
Splitting is when you divide your mortgage in two, with one part fixed and the other part variable. You can split equally, but you don’t have to. So you might decide to make 30 per cent of your loan fixed and 70 per cent variable; or 60 per cent fixed and 40 per cent variable.
Technically, you’ll actually be taking out two mortgages. This can work to your advantage if the fixed-rate loan doesn’t have offset or redraw but the variable loan does.
Of course, if you split your loan, you not only sign up for all the advantages of variable loans and fixed loans, you also sign up for all the disadvantages.
At the risk of stating the obvious, this is a complicated decision, so it’s a good idea to take professional advice before signing on the dotted line.