Analysis: Is it worth fixing your home loan?

Many economists are tipping the official cash interest rate will stay on hold for several months to come.

Financial market indicators also suggest there are strong expectations of interest rate stability, with a small chance of further cuts.

As late as Thursday 1 May, just days before the latest RBA cash rate announcement, the ASX 30 Day Interbank Cash Rate Futures May 2014 contract (which shows market expectations of an RBA interest rate change) was trading at 97.505. That indicates financial market participants thought there was a 98% chance that interest rates would be left on hold and a 2% chance of a cut to 2.25% at today’s RBA Board meeting.

For mortgage holders, low interest rates are providing opportunities to save considerable sums on their home loans.

Several lenders have cut mortgage rates since the start of this year, while the RBA has left the cash rate untouched at 2.5% since August 2013.

At least seven lenders have cut mortgage rates on their variable loans, according to finder.com.au. The comparison website found Yellow Brick Road, ANZ, Bank of Queensland, Citibank, Homeloans, HSBC and Westpac had all cut their variable rates since January 1. At the end of April, Loans.com.au was advertising an ongoing variable rate of just 4.49% on its Dream Home Loan, finder.com.au reported.

However, Finder.com.au money expert Michelle Hutchison says three-year fixed rates are still lower on average than variable rate home loans.

The RBA’s indicator rate for a three-year fixed rate mortgage dropped to 5.2% in March from 5.25% in February, the latest RBA statistics show. The average three-year rate available to consumers is a little lower, at 5.11%, according to finder.com.au.

History shows lenders typically pre-empt movements in the official cash rate with their fixed rate home loans, so by the time the RBA starts lifting rates, the fixed mortgage rates available to borrowers have already reached their bottom and started to trend higher (See chart).

Source: RBA

“If you're worried about interest rates rising in the next few years it might be time to consider locking in a fixed rate,” Hutchison says.

Property Observer asked finder.com.au to crunch the numbers on the cost over the next four years of taking out a fixed rate home loan now, compared with taking out a variable rate loan.

"The average three-year fixed rate is 5.11% while the average variable rate is 5.39%,” Hutchison says. “If variable interest rates increased back to normal levels of around 7% in four years, borrowers could be better off fixing.”

For this example, we assumed that the average variable interest rate available to consumers of 5.39% would remain in place for 12 months. After that time frame, we assumed interest rates would rise by 0.25 basis points every six months for remaining three years.

We compared that variable rate loan to a mortgage with the average three-year fixed rate of 5.11%. At the end of the three years, we assumed the interest rate for the fixed rate mortgage would revert to the same variable rate as the variable loan in the example: so 6.64% after three years, and then lifting to 6.89% for the last six months of the four year period.

Both sets of figures were calculated based on a loan with an initial size of $300,000.

Results

According to finder.com.au’s sums, the total cost over four years of the variable loan above was $93,246.

The total cost for the three-year fixed loan, reverting to the average variable loan rate at the end of the fixed period, was $88,732.

In this example, the three-year fixed rate loan would cost $4,514 less than the variable rate loan.

Of course, the results will vary if these assumptions on interest rate movements are off the mark.

Plus, there are other considerations when deciding between a fixed and variable rate mortgage, such as the flexibility to make additional repayments with the view of paying off the loan more quickly, which is usually only possible with a variable rate loan.

We’ve also excluded the affect of fees, and have ignored any other features that might be available with one loan but not the other.

In general, if it’s cost alone that you’re looking at, fixing the rate might still make sense.