Home loans – principal & interest – fixed rate

Fixed home loan rates are where the borrower’s interest rate and principal and interest repayments are fixed for a set period, usually from one to 10 years, and sometimes longer. Fixed home loan rates commonly revert to the standard variable rate at the time the fixed-rate period has expired, unless “rolled over” for another fixed-rate term (at prevailing fixed rates).

Should I fix my interest rate?

There are a number of reasons for considering a fixed home loan rate so whether or not to fix your home loan is a very personal decision.

Cost (or interest rate) is certainly one of those main reasons. As a general guideline, if you are contemplating a three-year, fixed home loan rate, you need the average of the variable rate over the three-year period to be higher than the fixed rate if you are to come out ahead on the overall costs.

Another very common reason for choosing a fixed home loan rate is to take advantage of the certainty it will give you over your home loan repayments.

Particularly if you are an investor or a first home buyer, a fixed home loan rate may be worth it for the security it provides, regardless of the actual costs involved. Think of it as an insurance premium.

Special fixed home loan rates are also regularly available if you know where to look. Our sister company, Loan Market, has access to a number of special home loan offers, including on fixed home loan rates. Visit their Special Offers page for more information.

How fixed rates work

Most people do not understand that variable interest rate movements and fixed interest rate movements do not come from the same source. They are certainly linked, but the drivers are totally different. Variable rates are driven by Reserve Bank policy and individual lender costs; fixed rates are driven by the views of those that put their money out to the fixed rate wholesale market.

Keep an eye on bank bill swap rates

If you really want a good indicator on fixed rates, keep an eye on the movement of the 90-day bank bill swap rates. When you see these drop and lenders starting to pass the drop on, don’t jump in to a fixed home loan rate straight away, wait for the market to stabilise and then move. If you Google “bank bill swap rates”, you will find pages of sites with this data.

Also keep an eye on lenders and stay in touch with your mortgage broker so you know what is going on. There is huge pressure on Australian lenders to continually compete in any way they can for your business. Fixed rates are a clear target for this. Lenders love fixed rate specials as they are predictable with a very small percentage of borrowers opting to refinance their home loan once they are on a fixed home loan rate.

Interest only home loans – fixed rate – monthly in arrears

Fixed rate interest only loans (monthly in arrears) are typically used by investors and offer you the potential protection of a fixed rate but have no requirement for any principal reduction. For those that have owner-occupied debt which they wish to pay off, but still want a fixed rate for their investment, this type of facility is often used. The fixed rate offers peace-of-mind in terms of cash-flow and you know exactly what your interest amount will be each month during the fixed rate term.

Should you sell your investment during the fixed rate period and want to clear the loan in full, you could be liable for fees, depending on where rates have moved from the time you originally fixed your loan.

Interest only home loans – fixed rate – annually in advance

Annual in advance interest only fixed rate loans have the same advantages as the monthly in arrears fixed rate home loan, but offer a significant tax advantage. The best way to describe how this loan works is with an example.

An investor purchases an investment property in March and has a loan of $300,000. Initially, she decides to leave it on a variable rate line of credit (LOC) and during the month of June decides to fix it for 3 years with interest payments annually in advance. For that financial year, she will have the interest she paid on the LOC from March to June and the interest in advance (relating to the next financial year). This has given the investor 16 months worth of interest deductions for that financial year, even though she has only owned the property for 4 months of that financial year. Thereafter, it will remain a normal 12 months worth of deductions each financial year.

The fixed rates for interest in advance facilities are always less than the fixed rate interest only monthly in arrears facilities and herein lies the economic advantage.

It is important to note that paying your interest in advance is not a tax minimisation strategy, but rather a tax deferment strategy, i.e. your tax bill is the same as if you paid monthly but the deduction is bought forward by 12 months. This is a great set-and-forget arrangement. You pay the interest upfront and then nothing else is required for the next 12 months.

Talk to your accountant about the suitability of this kind of arrangement for your situation.

Fixed rates – pros and cons