Fixed vs Variable

Crown Money, where we show you how to pay your home loan off in up to half the time of a normal bank loan. Welcome to the episode. I'm Jessie Edge and I'm joined by Scott Parry. How you going, buddy?

Not bad at all.

Awesome. What do you want to talk about today?

Let's talk fixed rates versus variable rates.

Yeah, great. Great. 1. So, well, let's just define them to start with.

Okay. Variable rate is obviously the rate goes up and down as a determined. It used to be as a reserve bank determines, but now the banks just jack them up or jack them. They never jack them down. The banks just tweak them whenever they feel like they need a little bit more profit. Variable rate is basically floating. It means it goes up and down as the banks and reserve banks determine. Fixed rates means it's locked in for one year, three years, two years, five years, however long it may be. For sure.

And I just want to touch on that again. People have got to remember that just because the reserve bank drops the interest rate does not mean the banks will.

I remember the very first time that delinked and I was, oh, wow, talk about shocked. So I always believed up until 2007 that the bank basic rate was determined by the Reserve bank in terms of if the Reserve bank dropped the rates by 0.25, well, guess what, your home loan goes down by 0.25. Then one day, I remember so clearly, I got a letter from the lender saying, we're actually increasing your rates. I was like, what? What? The Reserve bank hasn't moved? No, no, we're just increasing the rates on all clients. It's like, what the hell? I didn't know this was possible. And now it's the norm where it is the norm. The Reserve bank pass on 0.25. The banks are, we're not passing it on. We might give you 0.05 of the 0.25. And it's just such a profit grab. Everyone's noticed how quickly the lender passes on the rates when they. But when they go down, like they wait a month or two before it actually comes through on your loan. That month or two that they've stalled is millions and millions and millions of dollars extra profit.

Not that much money. And it did delink during the global financial crisis. It happened for a reason, because it became very difficult for banks to get funding. So there was a genuine thing that happened there. But what they then showed was that, oh, well, we've done it once, we can just keep doing it. And it has yeah, it has absolutely delinked it from then on. And it is really, really frustrating because clients will be like, well, the Reserve Bank's dropping the rate. Why isn't my rate going down? And the Reserve bank is dropping the rate for a reason. They're trying to control inflation or try to, you know, improve the economic growth. But that's, you know, banks are going, well, you know what, we need a little bit of extra money, so we're not going to do it.

Yes, total profit grab. You think about every single mortgage in Australia going and paying an extra 0.1 on their rate because they don't pass it on. That's like we're talking hundreds of millions of dollars profit to the banks just because they don't pass a full amount on. There's no extra marketing that's needed. There's no extra labor or staff or anything. That's pure profit just by holding back that point 1.

And usually if one bank does it, the others will follow suit because if they're doing it well, we don't have to because that's just what the market is doing.

I'm so, so sure. They sit around at a table and one bank says, oh, we'll go first this time. And then they just rotate it and so they're all in sync.

Yeah, that would be illegal, but they would do it anyway.

Who knows? I mean, it's just too coincidental that one bank goes, yep, we'll go first this time, take the hit and then the next.

And there's usually like one or two outlier banks that will use it as an opportunity to try and get a little bit more market share because they will reduce their rates even further. But again, that's only, you know, for people that are currently refinancing for the new rates. But yeah, so let's go back to fixed rates.

So, yeah, a lot of people say, should I fix in? Well, it's a difficult question. Fixed rates are the bank's expectations on where rates will be in three years or one year or five years, wherever you. Or whatever rate you fix in that. So at the moment, this is quite rare. I've obviously done this every day of my life for 18 years. The fixed rates are lower than the variable rates. What that means is the banks foresee more rate reductions on the way, and their bet is that rates will be lower, variable rates will be lower than that fixed rate they're offering you. That's why they're offering you a fixed rate to try and make more money out of you. They don't say you're a good guy. I want to give you the cheapest fixed rate possible. Their mindset is we believe the rates will be lower than that fixed rate in that two year or three year or five year time periods.

And also what we're seeing at the moment is because the rates are so low and competition between the banks is insane at the moment, what they're offering the cashbacks, like really low interest rates, what they're doing at the moment. So what they're saying is, you know, a lot of people are refinancing, so they use the fixed rate as a tool to trap you, to lock you in because they don't want you to go to another lender.

The downside of a fixed rate? Yeah, we're getting a cheap fixed rate, which is great for one, two, three or five years. The downside is you can only pay a certain amount off the principal fixed rate per year.

Usually like 10 or 20 grand, depending on the bank.

So it stores your debt reduction. I mean, our average client pays 30 grand off their mortgage per year. That's our average client. We've got clients paying 100 grand a year off their mortgage. We've got other clients paying 8, 10 grand a year off their mortgage, but our average is 30. And so what that would do for our clients is it would stall their debt reduction because they can only pay ten grand off that home loan if they fixed all of it in.

So it doesn't matter how cheap the rate is if you're not paying down debt. Like that's the number one goal. And that's why, I mean, we would, and it would depend on the situation, but we would pretty much never ever fix in 100% of a person's loan.

Exactly. So what we usually recommend, if you do want to fix, maybe fix half the loan or three quarters of the loan so the majority of the loan is fixed. But you've also got the variable part where you can still do the debt reduction, you can still pay down the debt, you can still create equity in your home and improve your financial position and your net worth.

Yeah, you just need to make sure you work out how much am I going to be paying off my loan over this year? You know, through my debt reduction strategies, you make sure you cover that for, say it's a two year fixed rate and you're paying off 30 grand a year. Then you need to make sure your variable split is at least $60,000 and then the rest you can consider fixing. It's important to remember as well, is what happens if you break a fixed rate?

Yeah, a lot of people don't ever anticipate breaking a fixed rate, obviously. But hey, you get divorced, you've got to sell your property. Hey, you've got to sell your property because you've got a job in another area. There's a lot of reasons over a three year or five year period that you may have to move that you can't foresee today.

There's absolutely no way you can predict what's going to happen in five years. Like we've just been through a global pandemic. Like nobody in the world. Well, except for Bill Gates, he predicted it, but nobody predicted that. And so a lot of people lost their jobs, had to sell or had to access equity or had to refinance or do something. And if you do that, you have to break your fix. And if you break your fixed, you'll have to contact your bank and ask for a fixed rate break quote. And usually it can be in the vicinity. I mean, we've seen some up to like 7 grand sometimes.

How do they work that out? It's a special formulation or calculation every bank does have. They don't make that public. You can't do the calculation yourself. But what it really comes back down to is how much longer is left on that fixed rate and how much cheaper could they have to resell that money for? If you obviously break the fixed rate, they get that money back. And then if the rates are lower than what you fixed in that, then they say, hey, we would have made more money if we had that money lent out to you still. And so you've got to pay that difference, that profit that we built into this fixed rate. You're paying it upfront. That's what it is, a seven grand upfront payment. Because that's the difference in the profit that we would get if we had the money still lent out to you at that higher fixed rate than the variable rate, say, which may be lower. On the flip side, if you have a fixed rate which is so low and the rates have gone up, theoretically the bank should pay you to break the fix.

They're not going to pay either, but they won't charge you.

I have not seen that to date, have not seen that, that today. So, yeah, that, that was the only sort of way where things are a little bit less at risk is if rates are moving up and you've got a super low fixed rate, then great, you're not going to have any penalties for breaking it.

Yeah, and I think as well, you know, at the moment we're seeing incredibly low interest rates and incredibly low fixed rates. So it's definitely, you know, there is, there's not actually much further they can go down. So as a strategy, it's not the worst idea to be fixing right now. But at the same time, unless you can foresee rates starting to go back up again, what would you say? Is it really worth fixing right now or.

It all depends on your income, how much you're paying off the loan, how much you've got left to owe, and as a result, that strategy. So if you do have any questions, I can run all the numbers for you. Do all the calculations, reach out to us, we'll tell you. Okay, this is where you sit. The optimum strategy for where you are today over the next three years would be to fix, let's say half a fixed 75%. Don't fix it.

Investment properties. Yes, that's the other one. If you've got investment properties and you fix for two years, the fixed rates are really, really competitive at the moment. So locking that in, it guarantee you know exactly your numbers then for the next two years.

That's critical. Really good point. If you do have an investment property, I highly, highly recommend to fix interest only because then you can budget exactly what that investment property is going to cost you cash flow wise for the next three years or how long you fix for. I'm not a big fan of the five year fix. I just think it's too far away.

So much that can change in five years nowadays. It really is.

I mean, I look at 1, 2, 3 fixes primarily for flexibility. 5 year fixes, I just don't do a lot of them personally. I obviously got my investment property portfolio and I'm really never fixing for more than three years.

Yeah, I mean I might, you know, I might reconsider that if the economy started turning around, you know, was booming, you know, rates are starting to head back up again. That's when you'd be like, well look, this is the lowest the rates have been in a very long time. Let's lock it in for a little bit longer. But that's, you know, that's a big decision to make. That's a big commitment to make. Definitely.

Yeah. I mean you want to really probably wait for that first rate rise before you start making that decision. Not guessing when they're going to put rates on. Because I don't think rates going to be going up for a long time.

Yeah, it's going to be so interesting to Watch. Absolutely. Yeah. So fixed rates, you know, something definitely keep it. You know, I think people think that if variable rates are low, then fixed rates are going to be low. But that's absolutely not the case either, is it?

No. I mean, my whole career, fixed rates have always been higher than variable rates. Now variable rates are higher than fixed rates. And so, yeah, it's like the bank's betting that the rates are going to be lower than the fixed rate they're giving you in that period over that next two years. Yeah.

And they're trying to lock you in because it's so competitive.

The bottom line is, over the history of interest rate rates, the variable rates have always outperformed the fixed rates, as I. E. They're cheaper for you in the long run. All the studies have been done. You can't. These banks are so smart. You're making $2.8 million per hour. Like you know the numbers, as opposed to us sitting out.

Well, I think the fixed rate is for sure.

So you've got to take into account these guys are so smart, they see the future so much clearer than what we do. And if they're saying that the fixed rates, at that point we go, that's super cheap. They're actually betting that their variable rate is going to be even lower than that in that period of time. So take that into account. Bottom line here is variable rates have always, over the term of interest rates, have outperformed and been better for the consumer than fixed rates.

Absolutely. Awesome. I think that's some really good information. So thank you for that, Scott. We'll look forward to speaking again next time.

Ciao.