Monday 21 May 2012
Professional investors understand that you can’t outsmart the market. It’s a lesson worth remembering if you’re looking at refinancing a loan with a fixed-rate loan.
Some borrowers have legtimate reasons to want fixed costs of capital. But there are other types of borrowers who believe that they will gain an advantage by taking a fixed rate loan.
We saw this happen in March when, according to the Australian Bureau of Statistics, the number of fixed-rate mortgages soared to 14.5% of the total mortgage market, the highest ratio since May 2008.
A flat economy (in the southern and eastern states), and a pause on official interest rate movements, pushed many Australians into the “safe” option because banks were offering fixed rates about 0.5 percentage points under their variable rates.
But the large numbers of borrowers refinancing into a fixed-rate loan in March were not to know that the Reserve Bank, on May 1, would cut the cash rate by 0.5 percentage points. They didn’t gain advantage at all.
Mortgage holders are generally best served by the variable-rate system, because you are following the market price of mortgages and you can operate with the same basic information available to everyone.
To find the best deal on a variable-rate loan, go to a comparison web site and look at the “comparison rate” column.
Then, focus on the loan margins. Start with your own variable home loan rate and subtract the cash rate, which you can find at the Reserve Bank’s home page.
So, if your loan is 6.75% and the cash rate is 3.75%, the margin you are paying is 3%.
Now, look at another lender’s variable rate. If they have a loan at 6.25%, then the margin they are charging is only 2.5%.
By thinking in terms of the loan margin, you get a better feel for the market.
The best part about variable rate loans is that while a fixed rate locks you in for a term, variable rate loans are flexible; lenders cannot charge exit fees when a borrower leaves a home loan, so there is no penalty for refinancing.
Refinancing is certainly worth it. Say you have a home loan with a bank and have a current variable interest rate of 6.99% on a $350,000 loan. You look around and decide to refinance to a 5.99% loan.
The savings in that one percentage point would be $59,223 over the life of the loan. If you refinanced and kept your repayments at the same rate as your repayments in the original loan, you’d actually save $129,143.
Some people are not comfortable researching the mortgage market, and for them I recommend expert advice in the form of a mortgage broker.
It doesn’t matter how you come to refinance, the trick is be informed and to be prepared to act. In most cases, the lender you are leaving will try to reduce you interest rate to make you stay.
It’s nice to feel wanted!