Fixed vs variable: backing the right one

By Gillian Bullock

You may well be licking your wounds now if you took out a three-year fixed loan in the first half of 2008, when home loan interest rates looked to be heading skyward. But that doesn't mean that fixed loans are necessarily a bad idea now that rates are falling at a rate of knots.

At the beginning of the year, almost 30 percent of home loans were fixed as borrowers believed rates would top 10 percent. The going rate then for a three-year fixed loan was 9 percent. The repayment on an average loan of $250,000 at 9 percent was $2097 a month. This is pretty tough when friends and family with a variable rate are now only paying some 6.8 percent interest with a monthly repayment of $1735.

Over the three-year term of the fixed loan, this works out at an extra $13,000 over the repayments of a variable rate.

As a result, it is no surprise that lenders are receiving a string of enquiries from borrowers who want to get out of their fixed-loan terms.

But such a move is probably not worth it. According to Harry Senlitonga of ratings watcher Cannex, unless interest rates were to fall by more than 1 percent a year for the duration of the three-year loan, then you would be out of pocket.

Getting out of the loan now, after just six months, would cost you an estimated $17,000 in break costs. Even waiting six months would only see the figure drop to $14,000.

"If the interest rate falls by less than 1 percent every year, then the break costs would cost you more than you are paying in repayments," says Senlitonga.

Three factors are used when lenders calculate break costs: how much is left on the loan; the amount of the loan; and the difference in the rate locked in and the current interest rate. In a rising interest rate market, break costs can be quite low as the lenders can re-lend the money at a higher rate. It's the opposite in a falling interest rate market.

But that doesn't mean you shouldn't still consider fixing your loan. While the number of people opting for a fixed loan has dropped to around 3 percent, according to figures from the Australian Bureau of Statistics, fixed rates are so attractive at the moment that they are certainly worth consideration.

For instance, you can now lock into a three-year fixed-term loan with a rate of just 5.19 percent. That makes for monthly repayments of $1489, which is more than $500 a month lower than had you locked in at 9 percent earlier this year and still well below the $1735 repayment on an average 6.8 percent variable rate.

There are pros and cons for fixed term loans. On the plus side you have the security of knowing exactly how much your repayments will be month by month so you can budget better. But on the negative side, more often than not, you cannot make additional payments.

And of course, if you pick the market wrong — as so many did at the start of this year — then you are locked into a fixed repayment when many other mortgagees around you are enjoying the lower rate regime.

At the end of the day, it's really up to the individual to assess their own needs based on their current position as to whether they should fix or not.

And while it may seem that variable is the way to go in the current climate, it might still be worth looking at hedging by fixing some of your home loan. With rates fixed as low as 5.19 percent for the next three years, you might still end up ahead when the term draws to an end.

Refinancers tools:
Mortgage calculator Is it time to refinance? More tips and guides