Fixed Vs. Floating, Plus Lessons from the “Frog in Hot Water” Parable

With interest rates still dropping is now the time to fix and lock in these good rates? Or should we float and hope they drop even further? And what advice can the frog in boiling water offer?

I really had to call this blog, Fixed vs Floating as it is the only title we run with month after month and it is our most consistently read blog. We are all very interested in interest rates and what to do with our mortgages.

As a reader of this most-popular-of-blogs you will know that the OCR dropped again today by 0.25% and now sits at 2.75% (as at time of writing 10 September 2015). This saw most banks drop their floating rates by a corresponding margin and an average floating rate before discounting is around 5.9%-6.00%.

In the last week many banks, seemingly in anticipation of today’s announcement, dropped their interest rates. The sharpest (discounted) rate on the market is a 1-year 4.35% rate, while 2-year rates are being advertised at 4.65%, and 3-year rates under 5%. 5-year rates are nudging closer to that 5% mark as well. 

The Governor of the Reserve Bank indicated it was likely there would be further decreases in the OCR this year.

So this is all good times if you are the proud owner of a home loan (unless of course your current fixed rate has years left on it to run and also unless you want to break a fixed rate loan—we are now seeing break costs regularly in the thousands and occasionally the tens of thousands of dollars)

So do you fix or do you float? As always it depends! There are now historically low rates available. If you are happy with those and you want some certainty, by all means, lock them in. 

If you think rates will go lower, keep floating for a bit (or fix for six months) and then lock in again in a few months time.

But what I really want to talk about is boiling frogs. You may well be acquainted with the parable (now surely banned as a science experiment due to cruelty) that if you put a frog in a pot of cold water and heat up the pot until it is boiling, the frog will stay in the water and … get boiled! If you boil a pot of water and throw a frog in … it will jump straight out. The moral of this story (which the more you think about it, the more macabre it becomes) is that creatures tolerate environments that they are gradually acclimatised to.

Here is the application of the gruesome parable: Our budgets are gradually acclimatising to lower interest rates. Two years ago having a “6” in our interest rates was good. Now, having a “4” in our interest rates is good. That is a third lower, people!

I bet most of us are still paying the minimum required on our mortgage and our budgets wouldn’t have even noticed the extra cash. What if we had kept our mortgage payments the same even though the interest rates have dropped? Answer, years off your mortgage!

This isn’t a big change to make but it does take an intentional action. Unless we are deliberate I humbly suggest this opportunity may very well be missed. We may not boil, but we will certainly be in debt for years longer than we need to be.

I just thought that might be worth mentioning.

 

Brendon Ojala is a Registered Financial Adviser with Velocity Financial. No investment decision should be taken based on the information in this blog alone. A disclosure statement is available free of charge upon request.