A common question being asked right now is “Would I be wise to fix my interest rates now for three years”? Are you a betting person? Fixing interest rates is gambling with your bank and there must be one winner and one loser. That is an overly simplistic view of how the world actually works, so let me offer some deeper insight so that by the end of this article you will be better equipped to answer your own fixing interest rate questions.

Casinos and Banks; The Winners and Losers

Casinos arrange games to ensure the house wins. You may beat the house short term… but we all know long term that gamblers lose. It’s much the same way with fixing rates according to research. Figures released a year ago by the mortgage industry concluded that a person was better off on a variable rate 83% of the time and that in 27 years of recorded figures you would have paid less interest with a variable product than with a fixed; in the majority of instances.

Official Cash Rates & Money Markets

The cost of a variable loan is determined by the official cash rate set by the Reserve Bank of Australia (RBA) plus a retail margin added by the bank. The cost of a fixed rate is determined by the bank gambling on what they will be able to buy money for via the money markets plus a retail margin.

Understand that banks assume a position of risk when offering you a fixed rate; they gamble on what their future funding will cost them. Their risk is in offering you a one, two, three or five year fixed rate with funds that carry money market fluctuation costs over the same time period. Any reasonably educated person with some understanding of how the world works must conclude that all banks must build into their margins a contingency for carrying that risk.

When you “buy” a variable loan you will pay according to whatever the official cash rate is at the time plus a margin for the bank to make a profit. When you “buy” a fixed rate loan you will pay a margin for the bank to make a profit PLUS a margin to cover their risk. Of course there will be a contingency for error or misinterpretation of future likely market movements. Therefore, logic says that with few exceptions, fixed rate loans must cost the consumer more than a variable loan that does not carry the same risk.

Casinos and Card Games

Simply put… when you are offered a fixed rate from a bank they are inviting you to sit in on their equivalent of a casinos betting table and statistically speaking you have only a 17% chance of a win!

Sometime back a guy who works with me @ mrd received an out of the blue call from his bank. The loans officer offered him a fixed rate; which he declined. Was this bank offering to switch customers to fixed rate loans to help them win? I rather suspect it was because money market funding looked as though it would become significantly cheaper moving forward, leaving banks with BIG profit margins on those they could lock in ahead of time.

How To Measure Risk

Risk is a measurement of knowledge. While it would be risky (a huge understatement) for me to rewire a house; it would be a “walk in the park” for an electrician. If it were important enough for me to learn how to do this myself there are plenty of ways that I could. I think I have a pretty reasonable grasp on our property market as well as things economic and as such prefer to back myself rather than gamble against the bank. I don’t want to pay the bank to carry my risk as my level of knowledge allows me to comfortably carry it myself.

If your level of investment knowledge resembles mine in the electrical arena… no doubt you may be really nervous about taking on any financial commitments. Because I believe that investing somewhere is that important to anyone not wanting to wind up broke I encourage you to either:

• Consider placing your confidence in the bank’s ability to pick the money markets and stick with a variable rate (as a general rule of thumb) or
• Prioritise developing the necessary knowledge so as to minimise risk yourself

The Advantage of Fixed Rates

The advantage of fixing your interest rates is in the certainty it offers. If the thought of your variable rate loan increasing keeps you awake at night worrying maybe you should fix. Remember that your new risk will be that you have an 83% chance of paying for your new found peace of mind; just as with any worthwhile insurance policy. To me it seems that the most sensible and least costly choice is to gather your own knowledge.

I empathise with those tens of thousands of frustrated Australians who fixed their rates in the past year or so. Wendy took a call this morning from an mrd client who chose to fix his rates in January past. He now finds himself locked in for another two and a bit years at 8.29%; OUCH!  Please do not fix your rates based on emotion or advice from anyone who lacks understanding of financial markets; even if they are bankers, financial advisers or finance brokers. As with all investment decisions you ought to be fully informed. I rely on an electrician who is competent and trustworthy to undertake my electrical work. This is certainly the blueprint I suggest you rely on before making those seemingly little investment decisions that actually have big consequences going forward!

PS: My mission is to earn your trust so that mrd will become your property investment mentor. That’s why our trading name is:
mrd your property investmentmentor.com.au

Rates will rise and rates will fall! It’s all part of normal economic cycles. For the property investor, rate rises normally produce rental (income) rises… albeit not immediately. Rate drops generally do not result in rental (income) drops! This is that part of the property cycle that draws investors back into the market and drives property values higher. So to me, either way property investors win!

An mrd client, whose property portfolio became cashflow neutral after the November rate cut, emailed and asked if he should now fix his rates. I will not answer such a question directly; to do so would be to offer financial advice. His and a couple of others asking similar questions prompted me to write this article; to educate and empower you to make your own better informed decisions. At the very least, I trust it has provided food for thought.

A General Suggestion

General speaking if someone is happy with current interest rates and locking in now would offer peace of mind; then going ahead and fixing may be their best “bet“. Remember, as part of the ongoing mrd customer care program we are committed to three important client check points… ahead of any investment decision:

1. You must have the borrowing capacity
2. You must know what your out of pocket expenses will be and possess the capacity and understanding to manage any funding shortfall
3. You should have the mental toughness capacity; or sleep at night factor.

If fixing rates helps with number three; go ahead. Considering you will have an 83% chance of being the loser a safer bet would be to increase knowledge and minimise risk that way. Knowledge leads to understanding which in turn fosters confidence. From there you can take those steps necessary to secure your family’s financial future.

Looking Ahead – Times Have Changed

I have never fixed my interest rates. I have a brother who did in mid 2005, for three years and he was one of those rare winners who “laughed all the way to the bank”. I am watching the market now and will let you know if and when I may decide to do so sometime in 2009. If I could get a fixed rate at 4.something% and I thought we were at the bottom of the cycle I would have to say even I would be sorely tempted to fix my loans. I would even look to locking in for a longer timeframe… but that is all based on a big IF such a great deal were to be offered… and I suspect not!

Happy Investing,

Nick Lockhart
mrd customer care program… because investing is personal

 Print This Page