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Home Loans - to fix or not to fix ?

Home loans: to fix or not to fix ?
Interest rates are on hold for now but economists expect the next move to be up.

Home buyers are turning to fixed-rate mortgages in response to the steady rise in interest rates last year and predictions that rates will go higher this year.

Mortgage broker AFG publishes a monthly mortgage index, which shows that the proportion of fixed-rate mortgages increased from just 2 per cent of its total new lending at the start of last year to 3.4 per cent in July and then 12.6 per cent in December.

With one-, two- and three-year fixed rates about the same level as (or lower than) variable rates, borrowers have little to lose by opting for fixed rates.

However, they need to recognise that fixed-rate loans have different characteristics to variable-rate loans and may not suit their needs (see box).

The general manager of sales at AFG, Mark Hewitt, says the rise in the popularity of fixed-rate home loans reflects increasing consumer concern about the future of interest rates.

For another big broker, Mortgage Choice, the level of demand for fixed rates has been even higher, reaching 15.2 per cent of its approvals in December. A spokeswoman for the group, Kristy Sheppard, says it was the biggest take-up of fixed rates in almost three years.

''Much has been said about the cautious approach Australians are taking to their finances and our figures reflect this,'' Sheppard says.

The Reserve Bank cash rate reached a low point of 3 per cent in April 2009 and started rising six months later. Since then it has gone up to 4.75 per cent, with the most recent change last November.

A trend noted by the Reserve Bank has been the marked increase in the range of interest rates offered for similar products. In the RBA's view, this may reflect the move by some lenders to compete on non-price criteria.

Whatever the reason, it makes it more important than ever for borrowers to keep track of rate changes.

One-year fixed rates start at 6.74 per cent for the Better Option Fixed Rate Home Loan. Lenders with one-year rates under 7 per cent include NAB, Gateway Credit Union, CUA, Homeside, QuickDirect, Laiki Bank, Heritage Building Society, HSBC and RAMS.

Two-year rates start at 6.99 per cent for the AMO Fixed Rate Home Loan and RESI Pro (Fixed). Lenders with two-year rates under 7.2 per cent include Bank of Queensland, Heritage, HSBC, Police Credit, Teachers Credit Union, Nationwide Mortgage, Gateway, IMB, MECU and Newcastle Permanent.

Three-year rates start at 7 per cent for Better Option. Lenders with three-year rates under 7.3 per cent include AMP, ANZ, Citibank, CUA, Heritage, HSBC, MECU, Teachers and IMB.

The variable home loan rates offered by the big banks start with NAB at 7.67 per cent. ANZ and St George's variable mortgage rates are 7.8 per cent, Commonwealth's is 7.18 per cent and Westpac's is 7.86 per cent.

Many borrowers who have sourced their loans from a big bank will be receiving a package discount of about 0.6 of a per cent. A number of smaller lenders also offer these discounts.

So, how will rates move in 2011?

ANZ's forecast is for the Reserve Bank's cash rate to rise from the current level of 4.75 per cent to 5.5 per cent by the end of this year. Commonwealth Bank also says the cash rate will reach 5.5 per cent by year end. Westpac is forecasting only one rate rise this year (but not saying how big it thinks that rise will be). NAB is forecasting 5.25 per cent by the end of the year.

If the economists at the big banks are right, the worst-case scenario for borrowers this year is Reserve Bank rate increases of 0.75 of a per cent - then there is the possibility that lenders will add something on top.

One issue to consider is how lenders will respond to further Reserve Bank increases in the cash rate this year. Canstar Cannex reported that only five out of 99 lenders it surveyed kept their variable home loan rate increases at the levels set by the Reserve Bank last year.

The rest all increased by more. In November, when the Reserve Bank put up rates by 0.25 of a per cent, the average home loan rate increase was 0.32 of a per cent. A home owner with a $300,000 mortgage on a 25-year term would pay an extra $150 a month if rates went up by 0.75 of a per cent to 8 per cent.

Repayments on a $500,000 loan would go up by $245 a month.

With fixed rates for two- and three-year terms so close to current variable rates, fixing is a low-risk strategy.

Borrowers have to pay a new establishment fee but may end up with a fixed-rate loan that is lower than the variable rate they are paying now.

If rates do move this year they will be ahead.

Fixed rates are different

Borrowers need to remember that, generally, fixed-rate loans are inflexible. Monthly payments cannot be varied, there is no redraw and no offset.

To avoid problems that might arise from this inflexibility, borrowers should discuss a split loan (part variable and part fixed) with their broker or lender. The fixed portion will give them protection from rate increases and they will be able to make additional payments into the variable portion.

Being able to make extra repayments is an important facility. According to ING Direct's Financial Wellbeing index, 48 per cent of home loan borrowers make extra repayments on their loans.

These payments serve two purposes: they create a buffer that can be called upon in emergencies and they speed up the repayment of the loan. Even small amounts help; a monthly payment of $1996 on a 30-year $300,000 loan rounded up to $2050 will cut $25,000 off the interest bill.

Posted by John Kavanagh - The Age Money on 16th February, 2011 | Comments | Trackbacks

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