Q  Our current mortgage debt is $485,000. I have been offered what I believe to be an excellent mortgage rate of 4.75% fixed for 2 years.  My current variable rate loan is 5.3% p.a. Should I fix my home loan or hope that rates continue to fall? Should I also consider switching the loan from Interest Only to Principle and Interest?

A “To fix or not to fix” that is the question!

As a general principle you should only consider fixing a home loan in the following situations; Fixed rates are lower than variable rates.  Your family’s cashflow is tight and your mortgage is of a size that if interest rates were to move, they would significantly impede your ability to service your debt. You were of the opinion that interest rates were likely to rise in the future.  Or if you wanted the certainty of knowing what your mortgage costs were likely to be.

If you are basing your decision purely on the direction of interest rates, for you to be worse off by fixing, you would have to assume the Reserve Bank was to cut interest rates further by more than half a percent and lending institutions would pass those cuts on to borrowers.  Remember also that if interest rates were to fall by more than half a percent, there is no guarantee that fixed rates would also fall.

Assuming you felt that the rate cuts were unlikely, I would only fix the portion of the loan that you felt you would not be able to repay over the length of time the loan is fixed.  For example, if your loan was $450,000 and you felt that you would be in a position to make additional payments beyond your mortgage obligation by $2,000 per month, I would fix no more than $400,000 for the 2 years and leave the remainder as variable.

Consider establishing an offset account that your income is paid into.  Link this to the variable portion of your loan.  As the name suggests, the account balance of the offset account, offsets the interest charged on the variable portion of your loan.  If you wish to fix a portion of your debt, establish a fixed term sub account that the repayments are serviced by the offset account

A disadvantage of fixing is that you are locked in to a lender for the duration of the fixed rate period.  To break a fixed rate loan may incur costs that make moving unviable.

The advantage of a Principle and Interest (P and I) loan is that the balance gets paid down over time regardless of whether you make additional payments or not.  The advantage of Interest only is that the minimum repayment will always be the interest payment only. Under either option, you are able to make additional repayments. If you feel you lack the discipline to make additional loan repayments, then a P and I loan may suit you better.

The rate quoted appears competitive but shop around, rates and features constantly change.


Follow Andrew on Twitter @AndrewHeavenFP.  This article was originally published in The Australian.