Fixed vs Floating

The OCR continues at its historical low and predictions are signalling further drops. So do we lock in the good rates for the future or enjoy the even better floating rates now? Brendon explores the options.


Every day I am asked, "What are interest rates going to do?” The real question behind this question is of course “What is going to happen to my mortgage rates?”


To answer the first question, the official cash rate is at an historical low of 2.25% and most of the market, along with the Reserve Bank, have signalled the likelihood of one more further drop this year. The market is predicting this will happen on June 9th.


And the interesting thing is that the markets are predicting that these rates will stay low for some time (some time, being maybe two years).


However, there are other things that affect your mortgage interest rates other than just the Official Cash Rate. The longer-term rates are impacted by overseas markets, particularly by American interest rates. The messages out of the US are that these seem set to stay lower for longer than had been predicted last year.


The third thing which affects your mortgage interest rate is what the banks will accept as a “margin” between what it costs them to “buy money” via local deposit interest rates, wholesale markets, and so on, and what they will lend that money to you at. Right now this margin is pretty tight in historic terms (and no I don’t expect you to have any sympathy for the banks about this!). The reason for this is essentially competition and bank’s desire to “grow their book” of mortgages—to claim a bigger chunk of the market. At some stage making bigger profits will again become more important than market share, so this margin will increase.  Even if the first two factors we mention drop, if margins increase, mortgage rates may hold steady or even increase.


The question, however, remains this: To fix or to float?


If you believe the above, generally speaking, you will be looking to fix for a short period of time because they are the current cheapest interest rates. In the current market, 4.10% is already a good one-year rate and fixed rates increase up to around 4.80% for a really good five-year rate.


If you have got some of your mortgages on floating, then you would be hoping to be paying less than 5% for this money, assuming that you do have 20% equity in your property.


However, some people are still fixing for a longer time because they either don't believe that interest rates are going to stay low or they just really do need the certainty of repayments and the risk of increases in the next few years is just too great for their current circumstances.


As always, if you want flexibility, then some of your mortgage should probably stay on some form of floating interest rate to enable extra debt to be repaid.


The last thing I would say is if your interest rates are about to roll off a fixed-rate period, if you can currently still afford those payments then it almost always makes sense to continue with those higher payments even though you will be securing a lower interest rate.


There are only two exceptions to this:


1. If things are financially tight and keeping up the payments would risk the need to take on more secondary debt.


2. If you have an aggressive debt reduction strategy and are using offset mortgages or revolving credit accounts to reduce debt. The more you have in/against these loans the greater access to future funds you will have (but that is a whole new blog).


As always, Velocity Financial Advisers are willing to talk you through your options and come up with the strategy that is best for your situation.


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.