Is interest rate fixing worthwhile?
Accountants, bankers, financiers and financial planners are often asked whether interest rate fixing is ‘the best way to go’, particularly for home loan borrowers. If they are considering fixing the rate, they want to know: should they be fixed now; or should they risk them dropping further before fixing? This is a question that often arises around announcements by the Reserve Bank of Australia (the RBA) as to the official interest rate; and especially when that is to the lowest level ever on record (as at 3 August 2016); and so we set out below some of the issues that need to be considered when making such a decision.
[Note that we first posted this article in July 2009: and since which time, interest rates have only continued to fall. This may indicate that a rise in rates could be coming in the next round or two of moves by the RBA.]
How long will interest rates stay at current levels?
Which direction do you anticipate interest rates moving next?[A interest rate fixing may look attractive when signing up, but prove expensive if rates either fail to climb at the anticipated rate; or in fact, fall for some unforeseen reason. Note that you may be able to get some insight on which direction the professionals see the RBA moving, by looking at the rate offered by the lender.]
What timing do you believe will be applicable to the move in that direction?[If the time until the next increase in rates is too long, the fixed rate ‘premium’ may render the actual interest paid excessive to what would have been paid under the variable contract. We noted that early in 2016, many of the ‘pundits’ of the money markets were convinced that the RBA would not take official cash rates any lower. As it panned out, there have been two interest rate cuts since that time – and now ‘the market’ is speculating that yet further cuts will be announced.]
Is the loan you would consider ‘fixing’ one that is decidedly long-term?[Unless the loan is one that is going to have a ‘core’ element to it for the term of the interest rate fixing, the cost of the interest and/ or the ‘break fee’ could again render the actual interest too high.]
Should you fix the whole of the debt?[Given some of the above considerations, should the loan be split into a fixed and a variable portion. Advice should be sought as to the appropriate apportionment in individual circumstances. Whilst a ‘headline’ rate of interest might sound appealing, the actual interest cost is what has to be paid by the borrower – and that could be more than realised.]
How long a term should you fix any loan for?[Depending on some of the other considerations, a three-year term may be adequate; or if applicable – and other aspects are satisfied – the five-year option could be worth considering. Again this is a consideration that is very specific to each individual set of circumstances and we recommend that advice be sought before undertaking interest rate fixing.]
Is the loan secured against an asset that can be substituted if a disposal opportunity arises?[Not all loan documents are alike. Some allow for substitution, others don’t have that provision. If substitution is not available, a ‘break fee’ will most likely apply – and could prove expensive.]
Are there any business or other financial impediments to fixing all/ any portion of the loan?
Should you ‘fix’ any part of your loan to set interest rate?
It is often very difficult to get the timing right for this decision: borrowers have difficulty picking the rates that will apply for any time in the future; and they often have great difficulty determining what the future holds for some assets.
If fixing interest rates is something you want to consider at this time, we suggest that you contact your accountant, your financial planner and your loan manager to gather the information you need to make the right decision in your prevailing circumstances. To speak to an adviser at Continuum Financial Planners Pty Ltd, contact us – or call 07-34213456 for an appointment.
[This article was originally posted in July 2009: it has been refreshed and updated from time to time, most recently, in August 2016.]
