November 2008
My friend was wearing tattered jeans and a vintage tee shirt. I am sure both garments genuinely dated back to the early 80’s and probably from a charity bin. I detected the hint of camphor underneath the smell of his cheap spray-on deodorant. He drank the beer I had bought and then told me how his date was a disaster.
After making his date pay for the taxi and then splitting the bill, my friend didn’t even buy a round. After being so appallingly cheap it would appear that he had taken on all the qualities of a bank account. Without lots of money there was very little in the way of interest. This penny pinching was the result of his mortgage so we chatted through the merits of fixing the loan or going with a variable rate.
A variable rate loan means your repayment will fluctuate with movements in interest rates. When rates drop, as they have recently, your repayment will go down. But if rates climb, then so will your repayment.
This can be a blessing and a curse. You will get the benefit of a lower rate, though in tighter times you will watch your repayment increase and your beer budget decrease. Variable loans generally have more features than fixed loans. Unlimited additional repayments and redraw are more available with variable loans.
Additional repayments made will often clear your loan faster and save you interest. If you have a redraw feature on your loan, you can tap the extra equity that you have built. Variable loans sometimes have the added flexibility of 100% offset accounts, salary crediting and in some instances the ability to capitalize interest.
Fixed rate loans have their benefits, though these often come with a reduction in flexibility. Lenders will allow a borrower to fix their loan for a set period of time (generally one to five years, but sometimes longer) with a guaranteed rate.
When fixed, your repayment will not rise or drop with interest rate movements. This can save you money if rates shoot up. However, it is not always easy to call. Should you fix and the rate drops, you could be paying more for your loan than everyone else. You could also be up for penalty fees and interest if you want to switch to a variable loan.
Fixed rate loans can be inflexible in other ways too. They will either limit your additional repayments and redraws or stop you from making them all together. The core benefit you will get from fixing is the certainty of knowing what you repayment will be every month.
Fixed and variable contracts suit different people for different reasons. Sometime it is good to combine the two. By keeping some of your borrowings variable you preserve flexibility while the fixed component offers an anchor. Regardless, with lower rates hopefully my friend can afford to put his hand in his pocket and pay for the next round!
Evan Davis
