To fix or not to fix — that is the question

23 Sep 2014

By Shadforth Financial Group

Australian borrowers have traditionally been somewhat reluctant users of fixed rate borrowing options. Even with rates at historic lows, 80% of new lending is still being drawn at variable rather than fixed rates. The Australian experience is quite unusual by international standards where fixed rate borrowing is significantly more common. So, why are Australian borrowers such fans of the variable rate, and is now a good time to consider the fixed rate alternatives?

There are three factors to consider when determining whether to utilise a fixed rate for some or all of your borrowings.

  1. Your ability to 'time-the-market' - fixed rates can be used to reduce your total interest payments if you're able to secure a fixed rate which is lower rate than the average variable rate for the relevant period. 
  2. Your desire for certainty - fixed rates can reduce risk and increase certainty as you are protected from future increases to the variable rate for the fixed rate period. 
  3. Your need for flexibility - fixed rate loans generally have reduced flexibility in terms of your ability to redraw or to make additional repayments. 

In general, most commentary on fixed rate borrowings fixates on point one, with views being expressed on interest rate cycles and picking the bottom of the market. Whilst at first glance this focus on market timing makes some sense, further consideration highlights the folly of attempting market timing in debt markets any more than a similarly speculative approach to equity markets. In short, future interest rate movements are uncertain and inherently hard to predict. In any event, the market consensus of future interest rate movements is already embedded in the various rates available for different terms - that's why different terms have different applicable rates.

For these reasons, points two and three should be the primary focus for most borrowers on most occasions. For most borrowers, for example, the increased cash flow certainty provided by fixed rate borrowing is highly attractive. The trade-off for this reduced risk is a lack of flexibility however, this is easily managed in most cases by an appropriate splitting of facilities. For example, if your total borrowing is $800,000, spreading this debt across three facilities utilising a range of variable and fixed rate options can provide a good balance of certainty and flexibility…

Amount​​Fixed or variableTerm​
$200,000​​Variable​25 Years
​$250,000​​​Fixed​3 Years
​$350,000​​​Fixed​3 Years
 

Splitting your borrowings into multiple facilities can provide the best of both worlds!

Whilst focusing on certainty and flexibility, borrowers should also note that rates are at historic lows and the lenders are in a period of relatively fierce competition following a few more conservative years after the GFC. Whether you take advantage of a fixed rate or not, now is certainly a great time to review your options, on your own or with the assistance of a Shadforth Lending Specialist, to ensure you're taking advantage of what the market has to offer.

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