Should you fix your home loan?

Interest rates have been at record lows for most of 2016, after the Reserve Bank of Australia (RBA) cut the official cash rate twice this year, taking the rate to just 1.5%.

Standard variable mortgage interest rates offered by the big four banks Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) are available for around 5%.

Beating that, several lenders, including some subsidiaries of the banks, are even offering rates below 4%.

The problem for borrowers is knowing what interest rates will be in a year, two years’ or three years’ time. To obtain certainty, lenders do offer fixed rate mortgages, although the interest rates are often slightly higher than variable rates.

As an example, U Bank is offering a fixed home loan rate of 4.12% for 5 years. For the same borrowed amount, term and same 20% deposit, U Bank has a variable mortgage rate of 3.64%, according to RateCity.

Another problem borrowers face is that it’s hard to get a fixed rate loan for a period of more than 5 years. That’s because banks take on the risk of interest rates rising and need to price that into the price (interest rate) they charge. Just four lenders offer fixed rate loans for ten or twelve years, including Westpac, ANZ, Newcastle Permanent and Rams. And the lowest rate borrowers can get is 5.86% from Rams. ANZ’s fixed rate investment loan for 10 years carries a 7.24% interest rate.

Taking up ANZ’s 10-year fixed loan will only make financial sense if the borrower thinks interest rates will rise well above 7.24% within the next 10 years (and stay there).

However, there are better options for borrowers.

Taking out a 3,4 or 5-year fixed loan makes sense if the borrower believes interest rates will rise, and several lenders are offering fixed rates over those periods with interest rates of under 4%. Borrowers can also find lenders offering combination fixed and variable loans which might be even more attractive. That locks in a rate for a set period for a portion of your mortgage.

Looking ahead, the RBA’s latest statement on interest rates suggests the odds of interest rates rising within the next two years are growing. Now might be the perfect time to lock in a low-interest rate.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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