Beware of getting into a fix

IF YOU can feel the panic rising in your body about the possibility of higher interest rates, take a few deep breaths and consider this: all but the most hawkish commentators are saying there'll be no rises before the end of the year, with most tipping the middle of next year.

And the majority believe, once they commence, the official rate will quickly move up by a percentage point - from 3 per cent to 4 per cent - but very few are yet forecasting hikes beyond that.

So we are talking about the fairly distant prospect of a relatively small rise in your monthly mortgage repayments. Possibly $166 on a $275,000 loan.

The danger is that, as so often happens, borrowers will overreact to that thought and lock in a rate that will ultimately see them fork out more.

Just ask those who couldn't stomach any more rises and fixed in August last year at 9 per cent-plus, only to see rates plummet by 4.25 percentage points in seven months.

Before you make any similarly rash decisions, it's important to realise that fixed rates have already moved far above standard variable rates. You can't have missed the controversy over Westpac's rise early last week. Research house InfoChoice tells me the big four's average two-year rate now stands 0.73 percentage points higher than the average variable rate of 5.25 per cent; the average three-year rate, 1.38 points; and the average five-year, 2.1 points. So you'll be paying more - between $120 and $356 on your $275,000 mortgage - instantly.

To save money overall then, you need the variable rate to positively soar past your fixed rate. And fast.

But data provider RateCity expects no such thing. It says the market is tipping a rise of just 2 percentage points, taking us to a variable rate of 7.25 per cent, over the next five years. Which is what many institutions are charging for a five-year fix. However, RateCity's modelling shows if you took them up on the offer, you could find yourself $10,568 worse off. Assuming gradual rate rises over the time, interest on a variable loan would be $85,185 against a fix total of $95,753.

Not all it's cracked up to be, is it?

In any interest rate environment, it's vital to follow the fixing rules. Firstly, never lock in your whole mortgage. You want a fix to be a hedge against rising interest rates - not a boots-and-all bet that you are more clever than your bank (you know what they say about the house and winning). Opt for a maximum of half your mortgage.

Secondly, think carefully before fixing for more than three years. Look no further than the global financial crisis for a reminder that the fortunes of economies and therefore interest rates can turn on the head of a pin, and that even the most respected forecasters sometimes get it wrong.

Finally, remember most fixed loans don't allow extra repayments, which blocks your best avenue to turn record-low rates into enormous savings. Returning to the above example, paying the average extra cost of the fix of about $165 a month onto your variable rate loan for five years will save $1400 in interest and reduce your debt by $11,279.

Why were you thinking about fixing again?

Date: August 9, 2009  Publication:  The Age