To repair or not to repair? That is the question.
The national property market is cooling somewhat, and Labor and the Coalition are proposing ways to make it easier for first-time home buyers to unlock the key to a new property.
Before the election, homeownership for low- and middle-income people – without mum and dad’s bank – was little more than a pipe dream, but both sides of politics are now dangling the carrot of the great Australian dream.
The two main parties have outlined what you will need to earn, how much deposit you will need to pay, and what your regular monthly repayments will look like.
Labor will back the Coalition’s housing policy if the National Liberal Party also wins government, so either way the deposit many Australians will have to pay is set to plummet.
But no one can tell you whether to opt for a fixed rate or variable rate loan in the process.
So what’s the answer?
Six of one and half a dozen of another
An extraordinary number of borrowers panicked about the future of their finances when the pandemic hit in early 2020.
As a result, a large number of home buyers have taken out fixed rate loans over the past two years.
In fact, it has grown from about 15% to 50% of all new loans.
But that will change as the average fixed rate and average variable rate converge.
And this is the crucial point.
At the start of the pandemic, it was in the interest of banks and borrowers to lock in a cost of funding, and banks did so by making their fixed rate mortgage products competitive.
Recently, as the cost of finding fixed rate loans has increased for banks (as offshore interest rates rise) and the cost of finding short term funding (for fixed rate loans rate) remains very low, banks have encouraged customers to use variable rate loan products instead.
This cost for banks to obtain short-term funding (which they use for floating rate loans) is about to increase.
“We expect fixed and variable rates to slowly resemble each other over the next few years, as the reason fixed rates were so low relative to variable rates in 2020/2021 was because of the Bank stimulus. reserve,” said ANZ Research economist Adelaide Timbrell.
“It is now over and the Reserve Bank has started its tightening.
“It is unlikely that we will see such a huge gap [for a long period of time].”
Variable vs fixed payments
One way to measure the difference is to calculate the numbers for a typical loan, in terms of monthly mortgage repayments.
Let’s look at fixed rates first.
For example, if someone with a $500,000 loan, paying principal and interest set mid-last year at 1.92% for two years (the two-year average rate of the big four banks at this time), he would currently be paying $2,099 in monthly repayments.
When their fixed rate ends in June 2023, they would be looking at a return rate of around 5.33% (based on RateCity’s estimate of where the Reserve Bank’s cash rate will be). next year).
This means monthly repayments would increase to $2,947, an increase of $847 per month.
“Anyone who has locked in a fixed rate for the past two years has temporarily bought themselves some immunity from future rate hikes,” said Sally Tindall, director of research at RateCity.
“[But] return rates are often much higher than what banks offer to new customers.
“When they took out the fixed rate loan at the start of the pandemic, the rate of return would have looked more like 3.43%, so many people will be in shock because [variable] rates have probably more than doubled.”
That’s if they just accept the bank’s rate of return, instead of switching to another fixed rate deal or looking for a better variable rate.
So what will happen to variable rates?
If the Reserve Bank raises the cash rate target by 0.15 percentage points today (assuming that move also raises the actual cash rate), the average homeowner with $500,000 in debt and 25 years remaining will see their repayments increase by $39 per month.
If the RBA increases by 0.40 percentage points, as some economists predict, their reimbursements will increase by $104 per month.
Westpac predicts the cash rate will rise eight times by next May, taking it to 2%.
If that happens, the same borrower could see their monthly repayments increase by $511 per month on a variable loan.
The rise in interest rates is expected to continue for much of next year. And rates on new fixed-rate loans are already climbing.
Thus, the cost of variable rate loans is about to increase. Fixed rate loans may also increase, but perhaps the difference will not be as noticeable. It depends on the extent of inflationary pressure in the United States and more broadly abroad.
It’s important to remember that by taking out a fixed rate loan, you will have to cough up extra money if you refinance your loan at any time, move house, or break the contract for some other reason.
On a loan of hundreds of thousands of dollars, the breakage fee can add up to over $15,000.
The bottom line is that fixing a home loan gives you some peace of mind for a while, but there are restrictions on what you can do, including making additional repayments.
In contrast, variable rates are lower and more flexible but are about to rise, potentially quite significantly.
The answer as to whether to go for a fixed or variable rate loan is up to the borrower, but in terms of the cost of each option, over time analysts agree they are getting closer to each other – they converge.
The pandemic has muddied the waters for so many things we do in life, but it has made the decision of whether or not to repair a loan relatively simple.
Although you can argue as the cost of the two options get closer, the decision becomes easier – maybe.