Should I fix my home loan interest rate?

Welcome to Finance and Fury, the Say What Wednesday edition.

This week’s question is from Charl regarding his home loan.

“My bank is currently offering a 2.29% interest rate on a 3-year fixed loan. I am currently on a 2.99% Variable rate with them and am considering taking them up on this offer. I have funds in an offset account and don’t want to lose out of the flexibility of a variable loan. Do you think I should fix the majority of my loan and keep it variable on a small component, or keep it variable for now to see where the interest rates go?”

To fix or not –

1. Currently at record low interest rates – cash rate of 0.25%
2. But can go lower – RBA kept rates the same
3. But expectations that rates will be low for some time
   1. RBA ASX rate indicator

Future of interest rates –

1. Will rates go up?
2. The period is 3 years fixed – so in 3 years will variable rates will be higher?
3. Don’t see it – shape of the economy and debt levels have created a bit of a liquidity trap
   1. What if rates were to increase –
   2. Household debt to GDP – quite high
   3. Australia’s 6 million home loans, worth a collective $2.1 trillion
   4. Rate move of 0.25% means $5.25bn less to be spent in economy – given the demand side – keep rates low
4. What would it take for interest rates to go up?
   1. The economy to recover and for GDP to be back on track
   2. Or inflation kicks in with a vengeance – has happened – US and Aus and lots of Western nations
   3. inflation emerged as an economic and political challenge in the US in the 1970s. The monetary policiesof the Federal Reserve board, led by Volcker, were widely credited with curbing the rate of inflation and expectations that inflation would continue. US inflation, which peaked at 14.8 percent in March 1980, fell below 3 percent by 1983. 
   4. How did they do this – The Federal Reserve board led by Volcker raised the federal funds rate, which had averaged 11.2% in 1979, to a peak of 20% in June 1981. The prime raterose to 21.5% in 1981 as well, which helped lead to the 1980–1982 recession, in which the national unemployment rate rose to over 10%. 
   5. Australia followed suit as well with our – recession we had to have – was our last one in 1991 or so – The recession happened because of the unwinding of the excesses of the 1980s, the international recession of the early 1990s and the high interest rates – High interest rates were employed to slow the asset price boom of 1988–89 – Treasurer Keating, the Reserve Bank and Treasury itself generally agreed on the need for high interest rates in 1989 that lasted for 2 or so years –
   6. Our economy started to sink – The Government promised economic recovery for 1991 and launched a series of asset sales to increase revenue. GDP sank, unemployment rose, revenue collapsed and welfare payments surged.
   7. The recession started in the September quarter of 1990 and lasted until the September quarter of 1991. During the recession, GDP fell by 1.7 per cent, employment by 3.4 per cent and the unemployment rate rose to 10.8 per cent.
   8. but back then – Household debt to GDP was 40% – today it is 120% – 3 times larger compared to the ratio of the economy
5. Imagine today – the destruction of increased rates to a few percentage points –
   1. Economy already fragile – would create mass bankruptcies and a depression
   2. Not out of the question though – could be done but it would be done knowing that it would create a bad situation
6. Will they go down?
   1. They might – good chance that they will soon – depending on what happens next month with RBA –
   2. But cash rates are not bank interest rates – would need to be passed on
7. Does this mean that you will be worse off on a 2.29% fixed rate?
   1. Technically no – rate decrease of variable by 0.25% is still higher than 2.29%
   2. Looking at variable rates at the moment – sitting at about 3% for most big banks –
   3. The cash rate is 0.25% – if it goes to 0% and assuming the full thing is passed on – rates go down to 2.75%
      1. But looking at the cheaper rates –
   4. Does this low fixed rate mean that negative rates may be on the way? And What happens if they go into the negative territory?
      1. Would take some time to materialise –
      2. Could be offering low rates and fixing people in to secure loans at the bank level

• Also – banks own finding costs have been reduced from the RBA – so may be part of this

8. One factor – banks don’t like to lose money –
   
   2. Fixed rate of 2.29% seems to indicate they know something about the future of interest rates –
   3. Looking at longer term fixed rates – 5 years at 2.69% – don’t expect a rate increase for 5 years
   4. Also – variable rates – average is slightly below 3% – down to about 2.5% as some of the cheapest –

Issues with Fixed rates –

1. If rates go down below the fixed rate –
2. Breaking costs – if you have to sell the house – or discharge the loan – but if you are staying in there long term – the risk is lower

The strategy – not personal advice – what I would look at doing

1. Splitting – Keeping some variable –
   
   2. Fix at the 2.29% a decent size of the loan –
   3. Strategy is over a 3 year period – how much can be paid back in addition?
   4. Also – how much is sitting in an offset account –
   5. Want to keep a buffer on the variable size –
2. Also – see if you can Negotiate with bank for better variable – rate

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