The Fixing Question

It is one of the most frequent questions posed to mortgage brokers.

When should I fix my rate?

It’s a tough question to answer. Mortgage brokers don’t give financial advice. We can only try for clients to understand various reasons why fixing may or may not make sense.

Even during the once-in-a-generation opportunity at the end of 2021, when banks were offering fixed loans just above 2%, brokers may or may not have been pointing this out to clients.

Which brings me to today.

Rates are well up since those ZIRP days, and the markets as well as pundits are talking about rate cuts.

Its almost as if they’re a given.

Are they?

Before I continue, I just want to remind readers of the pros and cons:

Pros of Fixing Your Mortgage Rate:

• Peace of mind: Knowing your exact monthly payment for the fixed term provides stability and predictability, making budgeting and financial planning easier. You're protected from unexpected interest rate hikes, which can significantly impact your monthly costs.

• Protection against rising rates: If you believe interest rates are likely to rise in the future, locking in a lower rate today can save you money in the long run. This can be particularly beneficial if you anticipate significant financial changes, like starting a family or going back to school.

• Improved loan application competitiveness: In some cases, having a fixed-rate mortgage can make your loan application more competitive with lenders, especially during periods of rising rates.

Cons of Fixing Your Mortgage Rate:

• Missed opportunities: If interest rates fall during your fixed rate term, you'll be stuck paying a higher rate than what's available in the market. This could potentially cost you thousands of dollars over the course of the loan.

• Limited flexibility: Fixed-rate mortgages often come with restrictions on additional repayments. This can limit your ability to pay down your principal faster and save on interest in the long run. Some lenders may also charge exit fees if you want to refinance your loan to a different rate before the fixed term ends.

• Potentially higher initial rate: Fixed-rate mortgages typically carry a slightly higher interest rate than variable-rate mortgages at the outset. This is because lenders charge a premium for the certainty of knowing they will receive steady income throughout the fixed term.

Additional Considerations:

• Your financial goals: Are you prioritising stability and predictability in your monthly payments, or are you comfortable with some flexibility in exchange for the potential to save money if rates fall?

• Your risk tolerance: Are you comfortable with the possibility of missing out on lower rates if they occur during your fixed term?

• The length of the fixed term: Longer fixed terms offer greater certainty but also lock you into a rate for a longer period, increasing the risk of missing out on potential savings.

With that out of the way, let’s talk about what I am seeing in the lending market.

I would say a standard variable rate in the low 6’s, below 6.1%, is competitive.

If you’re paying more than 6.2% for an owner-occupier principal-and-interest home loan, ring me…like…NOW. (02) 9469 6676.

A certain bank is now offering 2-year fixed rates for owner-occupiers at 5.89%.

Prima facie, it appears to be about 0.15% lower than a standard variable.

I rang a client of mine telling her about this. She wasn’t impressed.

But rates are falling. Why should I tie myself up?

Fair point.

But without starting an undergraduate finance degree on Substack, I will try to explain why such a deal might make sense for some.

Time Value of Money in a Paragraph

Time is money, as they say.

In finance, time is measured in reference to opportunity cost. If I am to make a decision now for the future, how much will it impact me in today’s dollars, given my current situation?

Out of this question a whole profession emerges, based on the following formula:

𝑉𝑛=𝑉0∗(1+𝑟)𝑛

Sometimes, actually often, we forget about the time value of different values/rates.

A bank today is offering you a 0.15% discount to your interest rate for 2 years. If your view is rates will fall, when will they fall and by how much? Nobody knows, which makes the offer worth analysing. I will do so below.

How I analyse an offer

If I am offered a 2-year fixed loan at 5.89% and I am currently paying 6.02%, then I quickly need to work out the breakeven of the fixed loan offer. In simple terms, by how much and when would rates need to fall for this current offer to cost me the same amount as my current loan?

If I were to take up that fixed offer for $500,000, my repayment would be $2,962 a month and my loan balance after 2 years would be $486,515. During those 2 years I would be paying $60,577 of interest in aggregate.

But I am not paying all of the interest today. I am paying interest monthly, and at a declining rate. I need to factor this in, as per my formula above, and work out what in finance they call a Net Present Value (NPV).

The NPV of these interest payments is $57,179, assuming my alternative interest rate. That is, paying $57,179 in today’s dollars is the same as paying $60,577 over 2 years.

If I compare this offer to my current loan arrangement, I need to assume the following:

The RBA cash rate cuts by 25bp in February 2025 only.

In this scenario, being a rate cut in February next year only, the NPV of my existing loan is the same as the fixed offer.

Therefore, any interest rate cut that occurs sooner, or any additional rate cut, means I am better off staying put.

But everyone is expecting more rate cuts. Indeed, we can see the money markets imply what the RBA cash rate will be in the future, based on the interest rates they are trading bank bills. This occurs daily. What are they thinking right now?

As of Friday, the markets are expecting a rate cut around September 2024, with another one perhaps around March and September 2025.

How do we know they’re correct?

Hedging, not Speculating

I conclude with my pros and cons table above.

If one wants to base their future on what everyone is thinking about today, I would regard that as speculation.

But in knowing we do not know, it might make sense for some people if they want to fix a proportion of their mortgage by fixing it for 2 years, just in case everyone is wrong. It has happened before, and it can happen again.

Hedging your bets.

The cost in today’s dollars might not be a lot, and well worth it for them.

Of course, everyone is on their own journey.

If you want to discuss yours with me, you can contact me via email or the website.