Originally posted 5 December 2011

Q: I’m planning to buy an investment property for $590,000 with borrowings of about $300,000. Should I fix some or all of the mortgage interest rate to protect against a jump in RBA rates?

A: The argument to fix mortgage interest rates, or not, will depend on a range of factors. If your cash-flow won’t support a rise in interest rates, but can support the currently available fixed rate, then fixing may be a good idea to provide that peace of mind, regardless of any other factors.

However, assuming you have a cash-flow with some flexibility, you may wish to avoid fixed rates as they often impose restrictions or penalties on early or additional loan repayment. One common idea is to split your loan facility and fix part of the loan, providing some protection against an interest rate hike. This allows you to repay part of the debt quickly without penalty if funds become available. The exact amount of each should depend on the likelihood of a surplus in your cash-flow and your future capacity to repay.

Generally speaking, apart from providing certainty, borrowers choose a fixed rate if they believe that they will pay less interest during the term for doing so. If fixed rates are higher than variable rates, you’re starting off by paying more, in the hopes that you’ll pay less later on. This may not always work out. If fixed rates are lower than variable, however, your payments will be lower from day-one, increasing the chance that you will be ahead for a longer period.

A popular option when fixed rates are higher than variable is a “virtual fix”. Arrange with your bank to increase your repayments to what they would be under the (higher) fixed rate, and leave your rate variable. While you sustain this level of payment, you will be building up the redraw in your account. In addition, if and when rates do rise to match the fixed rate that was offered, your repayments should not change as you are already repaying at that level. If repayments go even higher, you will have your redraw to fall back on for at least a while, and if they do not go so high, you get to keep your redraw and your loan is repaid earlier.

Like most other financial decisions, the best answer often depends on your circumstances at the time and your ability to cope with volatility. Consider what you have to work with and what will work best for you. As a general principle, provided your cash-flow is ok, the old adage, “thou shalt not fix rates unless fixed rates are lower than viable rates”, still holds.

This article was published in The Australian on 20 August 2011. A direct link to the article can be found here.

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