24 September 2009


To Fix or Not To Fix?

The inevitable rise of interest rates, global credit fears continue, the dollar dips in value, oil prices hit new highs, record housing repossessions in the US - the headlines tell the story behind the increasing angst being felt by many in the Australian mortgage belt.

Should we fix our home loan or leave it in the hope that the variable rate will settle, or even come down, in the near future?

This is a common question at La Trobe and one which is difficult to answer because it involves accurately predicting the value of cash on the money market at any given time. As with all betting ventures there's a fifty percent chance of getting it right, as well as a fifty percent chance of getting it wrong. Bankers and economists see that there is a common misunderstanding by homeowners of fixed rate loans, which are priced to reflect average variable rates over a given period of time. However, once you understand the way financial markets and more importantly the interest rate markets work, it will help you evaluate special offers on fixed mortgages.

Basically, the money market rate for the fixed period of time of your loan will reflect how much the money market values its cash over that same period. The lending institution 'buys' the money on the money market and then 'sells' it on to you. Daily fluctuations in money market transactions will often occur because of this, particularly right now when the price of wholesale funds is volatile. Fixed rates are priced according to the bank bill swap rate (BBSW), a measure which reflects interest rate expectations for a certain period. Banks are constantly adjusting fixed-rate pricing to reflect the movements in the BBSW for different periods, in contrast to variable loan pricing, which generally tracks the Reserve Bank of Australia cash rate.

However, the natural process of supply and demand also affects the rate offered. For instance, if no-one is fixing their mortgages, institutions will offer a low interest rate to try to generate business. Conversely, if everyone rushes in to fix their loans, there is not as much incentive for the money lenders to keep interest rates temptingly low.

When is the best time to fix?

Unfortunately there is no best time to gain any advantage in fixing your mortgage, or part of it. There is no evidence in the last five years to suggest a particular week is the one to target for the best deal. Historical statistics on a three-year fixed rate loan show the average margin was 1%. We have seen figures as high as 1.85% and as low as 0.43% above the money market rate. The graph below illustrates the average margins taken over a 52 week period.

When timing your move to a fixed rate, it is essential to monitor the money market rate. This is available as a table in the finance section of most newspapers.

Graph
Click to enlarge

Is it a good deal?

A little research is always wise before you sign on the dotted line for a fixed-rate home loan. There's a fast, easy way to determine if an offer by your lender is a good deal or not. Simply check the interest rate percentage offered by your lender against the current money market rate for the same period of time as the fixed term in question. The closer the gap between the two the better the deal, and the more confident you can be in signing up for the fixed mortgage product in question.


Best regards
Iain Pepper




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Iain Pepper
Head of Lending

Iain Pepper is a Vice-President and the Head of Lending for the La Trobe Group.Read full profile here.








La Trobe is one of Australia's leading independent specialist mortgage Financiers. Its business includes residential mortgages, commercial mortgages, and investment services operating one of Australia's largest Mortgage Funds under AFSL 222213. It employs over 145 staff and has raised over AUD$10Billion to assist over 100,000 customers since inception in 1952.

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