Another Rate Cut, Is it time to Fix Your Mortgage ?

Today, 7 April 2009, Reserve Bank of Australia announce another interest cut of 25 basis point to 3.00%. Australia only see a rate this low in 1960, almost half century ago. So, all mortgage holder should be full of joy for this additional relief ! But the real question will be, is it the time to fix the mortgage ?

Do the Number

Let’s quickly do the number of  $350,000 home loan from Commonwealth Bank, the biggest lender in Australia. The current rate is 6.39% (for fixed rate) and 5.74% (for variable rate) and most likely only very little number pay that rate as somehow everybody qualify for “professional discount” or “wealth package discount” of 0.7% for variable rate but only 0.15% for fixed rate.  Commbank already announces that they will only pass 0.1% of the cut to their customer despite 0.25% cut of benchmark interest rate. Therefore, the final interest rate would be 6.24% (for 5 years fixed rate) and 4.94% (for variable rate) – assuming the fixed rate will be cut at the same rate as the variable (unlikely)

If you switch now you will be worse off by $264 per month. That’s not including the upfront establishment fee just to change from variable to fixed rate. This significant difference is the direct cause of that 1.2% difference of the interest rate between the fix and the variable. It simply too wide.

So, yes, at this moment do NOT fix your mortgage. The situation is not unique to Commonwealth Bank only, it will be quite common. If you do have that extra money to convert to fixed rate, then these are some suggestions that you need to consider in order to priority:

• Use the money to pay up loan with higher debt, for example credit card debt or car loan or other personal loan. Mortgage / homeloan is usually the cheapest debt you can get, so if you have other debt with higher rate do that one first.
• Put that money into your offset account to reduce the principal of the loan while building you up an emergency cash that you can access when there is a need.
• Put that $264 as extra repayment on your mortgage. This will save you thousands of dollar during the duration of your homeloan

When actually switching to the fixed rate is a better option:

1. When you really cannot afford further hike in the interest rate
2. The different between the fixed rate and the variable rate is below 0.6%-0.7% (so take only 2-3 interest rate hike before break even)
3. When you expect the economy to heats up: increasing stock market price or/and property market, increase GDP, government anticipate high inflation, etc
4. If the lender require you to have a fixed rate (usually if the lender doubt that you can sustain further interest rate increase)

In my opinion, while we are already past the worst chunk of the economy crisis, it will be at least another year before the economy take off again (and potentially make the interest rate higher in fear of inflation), but in the meantime the interest rate will stay around the same as it has only little bit room to go down.

A Big Relief for Gracious Australian

For a loan of 350k, a 30-years-mortgage holder Australian was paying around 9% interest rate on September 2008. That’s a repayment of $2816 per month. After these strings of cut, the same mortgage will cost only around 5% interest rate on April 2009, or a repayment of $1879. A huge saving of $937 per month. But as mentioned on other article here and here, the Aussie have more to cheer on: an average family with 2 school-age kids will also have huge $5600 real free money (tax free) from government since December 2008. (The detail is: 2x$1000 x’mas bonus per child,2x$900 back to school bonus per child, 2x$900 tax stimulus per tax payer)

As final word, with this good position we should all be gracious and maximize this condition to improve your financial position.

My medium term outlook will be looking economics to make a turn to the positive again but not that fast. It will takes 2-3 years before we are thinking about be in the similar condition before credit crunch hit the world.

Hope this helps