Fixed vs Floating

Last Thursday, 11 August 2016, the Official Cash Rate (OCR) dropped 25 points to 2 per cent. What does this mean for interest rates and the age-old question: to fix or to float?

 

Here are some things you need to know from the recent OCR announcement:

 

Impact on Floating Rates

The Official Cash Rate has a significant impact on mortgage floating rates. So straight after the announcement was made, most banks responded with a drop in their floating rates. Some dropped by the whole 25 points and some didn't. Some only dropped by 5 or 10. Those banks will give reasons why they didn't pass the full amount on to their customers and the customers themselves will make the decisions as to whether or not those reasons are valid!

 

Impact on Fixed Rates

Just because the OCR drops it doesn't mean fixed rates will necessarily follow suit. This is because fixed mortgage rates are determined by a range of factors, of which, the OCR is only one. Things such as wholesale rates, deposit rates, banks’ margins and what the competition does all affect how banks price their fixed rates.

 

In the weeks to come there may be some reduction in fixed rates. However, it is also possible that fixed rates won't be affected at all. When the official cash rate dropped in December, the 3-year fixed home loan actually went up (that was because the American Official Cash Rate increased) and wholesale rates, and then banks, moved in response to this.

 

Impact on You

I have a lot of clients waiting to fix their home loan rates in anticipation of drops. It's hard to predict if fixed rates will follow—only time will really tell. I would be surprised if there was a significant drop in fixed rates. However, there may be small reductions due to a whole range of factors in the weeks and months to come.

 

The Future

It does look like we will be in a low-interest-rate environment for some time. If you agree with that, then, the lowest fixed rates will generally be the best. This would give you the chance to keep locking in new rates in 1, 2, and 3 years’ time at still low rates.

 

If you are uncertain and think rates may rise, then taking a longer fixed rate, even if it is slightly higher would be a sensible decision. This may also be a sensible decision if small increases in rates will significantly affect your ability to repay your mortgage.

 

The Flexibility of Floating

For lots of people, having flexibility of repayment is also important and fixed rates takes away this flexibility. Therefore, having some of your home loans (even if it's a small percentage) on floating rates (which can include revolving credits or offset mortgages) can be a really useful way to maintain flexibility and give you the ability to pay off your mortgage in less time.

 

It all brings me back to this old mortgage broker saying: “It isn’t the interest rate but the rate you pay the interest that matters.” It’s clichéd but so true.

 

Make Hay While the Sun Shines

For almost everybody, when rates drop, keeping your mortgage payments the same is a really good strategy. It means that for the same interest rate, you are paying more off your mortgage and the length of your mortgage is shortened.

 

There are only two instances when this isn't a good strategy. The first is if your budget is very tight and you need to keep your mortgage to an absolute minimum for a period of time. The second applies if you are actively using a revolving credit account or offset mortgage and leaving all your spare funds in these accounts (and you are not tempted to spend these extra savings), in this case the best option may indeed be to reduce your fixed payments to a minimum.

 

As you can see, everyone is different. The Velocity Financial Team are more than happy to help you work through the best structure 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.