IT’S the one question I get asked more than any other as an economics commentator: should I fix my mortgage?
The question has become more pressing thanks to the eruption of a mortgage war between the big banks on their fixed-rate loans. Commonwealth Bank fired the first salvo last week, slashing its five year fixed rate to 4.99 per cent. Westpac and NAB quickly followed suit.
Make no mistake, that’s cheap. Variable mortgage rates have averaged around 7.5 per cent over the last two decades, so anything with a ‘4’ in front is good news for borrowers.
It’s unusual, too, because usually borrowers pay a premium for being fixed – you pay a higher interest rate for the certainty of knowing what your repayments will be. But today, the fixed rates on offer are substantially below the bank’s advertised standard variable rates of around 5.9 per cent (of course, most borrowers can negotiate a discount to that headline rate).
On the face of it, banks are essentially taking a punt that interest rates won’t rise from their current record lows for half a decade. That would be unprecedented. More likely, rates will rise during that time.
So just what are those banks up to?
First, banks can afford to discount rates because their funding costs have fallen dramatically recently as international investors have begun betting on lower interest rates for longer (unlike during the GFC when borrowing rates shot sky high because of fears about the stability of the entire financial system).
And let’s not forget those multi-billion dollar profits our banks have been reaping in. Even if the banks end up wearing some losses on these fixed loans, they may deem it worth it to dip into some of those fat profits to steal new customers.
And finally, with the federal government considering the recommendations of the David Murray financial system inquiry, now seems like a strategically wise time for a sudden display of conspicuous competition.
So, should you get involved in their war by switching to one of these cheap fixed rate loans?
The first thing to consider is what fees and strings are attached to what you can do with your money.
Fixed rate loans usually include break costs if you want to exit the mortgage before the end of the fixed term period.
And there are often restrictions on making additional repayments, should you come into some money unexpectedly. Overtime, the ability to pay off your loan faster may mean lower interest costs than the cheaper fixed rate.
As a nation, less than one in five Aussies usually opt to fix their mortgage.
This is in stark contrast to many other countries, where long term fixed rate loans are the norm. Traditionally Aussie borrowers have valued the ability to pay off their loans faster. Indeed, one of the biggest economic trends since the GFC has been the rise in borrowers getting ahead on their repayments.
Our historic preference for variable rate loans has served us well, even if it does make us a bit obsessed about interest rate moments. More people on variable rate loans means the Reserve Bank has a tighter grip on the economic reins, being able to influence household budgets more directly.
And before you jump in bed with the big banks, there are alternatives to consider.
Many smaller lenders are currently offering variable rate mortgages below 5 per cent. Before you opt to fix, why not try haggling on a variable rate loan? Many borrowers will be able to get as much as 1 or 1.5 percentage points off the headline standard variable rate just by ringing up the bank and asking – or, more importantly, threatening to leave.
At the end of the day, the decision to go fixed or variable is a gamble on where you think interest rate are heading.
Fixing in will protect you against interest rate rises, but it could also deny you the benefit of any interest rate cuts.
So, to my second most commonly asked (but related) question: where are interest rates heading?
In reality, it’s not possible to know for sure.
Inflation figures released last week showed inflation is at the top of the Reserve Bank’s comfort band at 3 per cent. Markets, which had been toying with the idea of further interest rate cuts, now view the prospect of further interest rate cuts as unlikely. The next move will likely be up, rather than down.
Cue speculation of imminent interest rate hikes!
But there’s another, more likely, possibility: that interest rates are simply set to remain at their current lows for a long period of time.
These are, after all, unusual times we live in. The United States is still printing money to pump its economy and many central banks have their interest rates at near zero per cent.
When it comes to global interest rates ‘lower for longer’ is the new mantra.
So either way you punt, fixed or variable, debt is cheap and likely to remain that way for some time.