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If one topic has dominated my conversations with clients in the last few months, it’s interest rates. I know I’ve written about this before and am unapologetic about it. It’s important to everybody, as it’s hitting us where it hurts most – in our wallets.
We can now see a glimmer of light – rates have begun to decrease in the last fortnight – at the end of the tunnel, and this changes the conversation from ‘if’ they’ll drop to ‘when, by how much, and how quickly.’
The most crucial questions you want answered are: “What the hell should I do now with my interest rate? Should I change banks? Should I approach my current bank? Should I fix it for a short period of time or a long period of time? Should I not fix it at all? Hmm, what should I do?”
We could go round and round in circles with these questions because there are so many variables, but I want to emphasise the two most important things:
- Firstly, when people ask me what they should do, it’s worth noting that it’s not a one-size-fits-all situation.
- Secondly, continuing to split your mortgage remains a good strategy, even with the imminent rate decrease.
No one-size fits all
If you post that question (or a version of it) in a Facebook group, I guarantee you’ll get 500 armchair critics giving you their two cents. Importantly, not one of those critics will say, ‘Tell me about your situation.’ Instead, they will launch into what they think you should do without considering your situation or needs. Their advice (if you can call it that) is usually to rattle off what they’ve done themselves – which is great for them but probably not for you!
For example, a client recently told me she read somewhere that rates would drop by 2% in about a year, so she wanted to fix her loan for just six months. I pointed out that her loan was only $30,000, and a 2% reduction would only save her $1 a month. Plus, she only had two years left on the loan. I recommended fixing it for the remaining two years for simplicity, which she did. Hers is an unusual situation, but my point is, context makes a difference, and each situation is different.
Splitting your mortgage: certainty is key
I can’t emphasise enough the importance of splitting your mortgage across different fixed rates. In uncertain times like this, it might be more sensible to prioritise stability over chasing the cheapest rate.
Over the last couple of years, if you split and spread your mortgage across two terms, you could avoid the impact of interest rate hikes. By splitting the mortgage, only half of it was affected by the increase, giving you time to adjust to the price hikes. That strategy has been beneficial for many people, especially in the last two to three years.
Now, with an imminent drop in interest rates, albeit gradual, the splitting strategy still makes sense, although for different reasons than when interest rates were rising. I can hear you asking, why would I split my mortgage if they’re about to fall? Why would I lock myself into a loan where I might be stuck?
The answer is that we don’t know how quickly they will fall. If you think about that, having some certainty in your mortgage setup makes sense.
The strategy of splitting has not changed much. That strategy has remained the same.
Splitting into shorter terms
So, we’re now talking to people about splitting into six, 12 and 18-month periods, whereas previously, we talked about longer terms such as 18 months or two years.
Deciding whether to opt for a lower rate for longer or a higher rate for shorter depends on future rate expectations. Since no one can predict this accurately, splitting the mortgage into shorter rate terms makes sense.
Break fees – are they worth it?
As an aside, many clients ask if it’s worth paying break fees. Break fees tend to be incurred where you want to get out of the fixed interest rate you are currently on. Most people want to do that because they see a lower rate on offer or anticipate a lower rate may be around the corner.
If the interest rate you want to break is higher than the prevailing interest rate in the market, the bank will charge a break fee. This is because the bank could not lend out the money at a similar or better interest rate than what it’s getting from you. The break fee represents the interest income the bank loses.
Why break now?
For the last several months, we’ve been in a position – or a ‘flat spot’ – where incurring a break fee was highly unlikely because interest rates were high.
However, with most banks already starting to drop their rates slightly, I’ve already seen some break fees being charged, and as rates continue to fall, so the quantum of break fees will increase.
If you anticipate rates falling and want to shorten your fixed rate expiry from, say, 2026 to, say, the end of 2024, although you’ll pay the same rate now as the one you’re currently on you’ll still incur a break fee. This is because the bank isn’t going to get that same interest income for another two years, they still lose, so you pay.
If you strongly believe that rates are about to crash, then breaking now rather than being stuck is something to consider.
Most people aren’t as gutsy, (or as foolish, depending on your perspective) as that, so we return to the more conservative strategy or….you know it…splitting.
Fix for a reasonably short period (when you next fix), so you don’t have too long to wait for the subsequent interest rate decrease.
In summary – don’t focus on the rate, focus on the stability
As Arthur Conan Doyle said, ‘It’s easy to be wise – after the event.’ This is especially true for fixed interest rate decisions, which are inherently uncertain. In the current context, opting for relatively short, fixed terms, not exceeding 18 months, but spread across different terms, can protect against timing errors. Focusing on the spread rather than the term, and not just the rate, is probably the wisest approach.
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