Fixed rate mortgage

Definition

A fixed rate mortgage refers to a loan where the interest rate does not change for an agreed period as opposed to a variable rate mortgage where the interest rate can be either increased or decreased from time to time. When you fix your rate, you are also locking in your minimum monthly, fortnightly or weekly repayments.

Fixed Rate Terms (duration)

Although you can repay your home loan across 30 and in some cases 40 years, the maximum period you can fix your rate for is 15 years. The most common terms are 3 to 5 years, with only a few offering longer terms.

Advantages

There are two advantages compelling borrowers to take out a fixed rate loan. The first is by fixing the rate, you are protecting yourself against interest rate fluctuations that may make it difficult to meet your repayments or cause you unreasonable financial distress. This is a popular reason for fixing amongst first home buyers who have never experienced the significant financial burden of a mortgage, people who need to use a large share of weekly income to meet repayments and property investors who are risk adverse.

The second advantage is that some fixed rate loans allow you to pay interest in advance, allowing for a tax deduction for the current year for an expense that would otherwise be incurred in the next financial year. Although not widespread, this reason for fixing is popular amongst investors, business owners and any other person that has financed investment property and is likely to experience significant income fluctuations year to year. This income fluctuation does not necessarily come from rental fluctuations and is often income derived from other sources. You should first talk with your accountant if you are considering taking out an interest in advance mortgage.

Disadvantages

There are several disadvantages to fixed rate mortgages. The first is a fixed rate mortgage is generally a more rigid loan that lacks the ability to offset your cash savings, limits the amount of extra payments you can make and does not allow access to those additional repayments until after the fixed rate has expired. Although there are some lenders that offer this type of interest saving flexibility, they are limited and the rigid style fixed rate is far more common.

Fixed rate mortgages lock in your rate regardless of whether fixed rates rise or fall. The result can be that you are locked into a rate that is much higher than if you had taken a variable rate option as fixed rate home loans also carry an early payout penalty called a break cost. This is designed to ensure the lender still makes a profit in the event that you 'break' the loan early to take advantage of lower rates. This break cost is most commonly defined in an 'economic loss' formula which means you don't know what the actual penalty will be until it is applied.

Beware of

Advertising. Good quality lenders will lock your rate early in the application process. If your lender does not offer the facility to lock your rate no later than formal approval you should view the lender with skepticism. It is usually months between when you first hear or see the rate and when your loan actually settles. If your rate is not locked during this period, it may increase sharply and you could find yourself locked into a higher rate for a number of years.

Pricing

Fixed rate mortgages usually attract higher interest rates than variable rate mortgages. Additionally, the longer the fixed rate term is, the higher the rate tends to be. Taking out a fixed rate mortgage is not about saving money on your home loan, but more about saving your home should rapid and unexpected interest rate increases occur.

Popularity

In Australia fixed rate mortgages are generally less popular than variable rate mortgages.