Fixed Interest Rates

15/05/2019

It is always a balancing act to discuss fixing interest rates.

The statistics tell us that the borrower loses most of the time (more than 80%). This is partly because borrowers move too early or more often too late in the rate changing cycle. It is also because financiers need to win because of the risk they are taking too.

In understanding longer term plan and objectives, fixing interest rates may or may not be a part of your strategy.

Fixing the interest rate on loans can provide certainty for cash flow but there are risks too.  A key consideration is the period of time that they see opportunity or risk.

In the past, for many mortgage brokers the discussion used to be centred around scenarios.  “How will it impact you in interest rates increase by 2%?”.  With the more granular review of cash flows required now, plus the much higher loan assessment rates, this is already a known commodity before getting to this point.

For commercial lending, a lead could be taken from mortgages where the conversation around this topic doesn’t happen enough. A story for another day.

The conversation on fixing should focus on:

– Whether there will be material changes to the loan during the fixed term considered (Extra Repayments, Discharge etc.)

– The pure and simple maths, do you want to play fixed and be one of the clever or lucky 20%?

Looking in Hindsight

So what else does history tell us?

Take the popular 3 Year P&I Fixed Rate Loan for Regulated Home Loans. We can look at all 3 Year Fixed Rates up to May 2016 – and roll forward to compare it with the average discounted variable rate over that period.

DateFixed Rate at DateAverage Variable Rate
(Over 3 Years)
Variable Savings
April 20107.58%5.75%1.83%
April 20117.11%5.24%1.87%
April 20126.11%4.67%1.94%
April 20135.14%4.27%0.87%
April 20144.90%4.03%0.87%
April 20154.50%3.82%0.68%
April 20164.15%3.74%0.41%

As you can see, over recent history, the variable option has always been the better one. Our analysis goes back a lot further, and there have been four predominately clusters of months were fixing was a good option.

The gap has narrowed significantly though, and this is not unexpected when approaching the bottom of an easing cycle.

So to answer the actual question, to fix or not? 

Monetary policy (via the Reserve Bank) may be less relevant but it is still the main driver of variable interest rates. It is difficult to anticipate what the future will hold, especially as the RBA are suggesting policy makers look at levers other than easing monetary policy.  This said, the market is pricing in a further fall.

The best guide is the money markets as they are based on the free market and impact fixed rates more readily. So with market rates low (the 3 Year Swap is crazy) it is no surprise that fixed interest rates are so low at present.

So let’s roll forward the table above. 3 Year Fixed Rates for example are around 3.55%, and a customer asks about its value.  The answer is the opportunity cost of the variable rate.  Remembering that the client will be say 20 basis points (0.20%) behind day 1 by not taking this offer, do you forecast that the variable rate will spend more time below 3.55% over the 3 year term?

It looks marginal.  As a sweeping comment too, the fixed rate benefits on investment mortgages and commercial loans is greater so this is well worth looking at.

We are in unprecedented times with rates at historical lows, with a nervous economy worldwide.

For any support for approaching these decisions please contact us.