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imagesWith an interest rate rise last week and the banks proving they are happy to move out of step with the Reserve Bank, many property owners will be wondering whether they should lock in the rate on their loans.

Fixing your interest rate provides certainty that the repayment amount for your loan won’t change, regardless of whether the Reserve Bank changes the official interest rate.

It is important to remember lenders are in the business of making profits by selling money. They are making a bet that the variable rate loan on average will be lower than the fixed rate they are offering and they rarely lose.

When you take out a fixed rate loan, you’re effectively paying a small insurance premium to protect yourself against repayment increases.

Most fixed rates run for one to five years, although some lenders offer 10- to 15-year terms. The longer the fixed-rate term, the higher the interest rate, because it becomes harder for the lender to accurately project the direction of official interest rate movements.

Generally speaking, fixed-rate loans differ from variable rate loans in a couple of ways. First, there is a limit to how much principal you can pay off. The ceiling for making additional repayments is usually around $5000-$10,000 a year above the minimum required amount.

In addition you may pay a penalty if you break a fixed-rate term and switch to a variable rate. If the official cash rate has dropped since you took out the loan, the variable rate will have dropped. The lender will incur a loss in comparison with the initial profit margin they set when you took out the loan, so they will charge a fee to compensate.

There is no hard and fast rule about whether, and when, it is appropriate to fix your interest rate. However here are a few general guidelines.

If you have debt on your family home and debt on an investment property, it may be wise to consider fixing your investment loan. This will enable you to focus on reducing the debt on your family home. Debt on your home should always be paid off first because it does not attract an income tax deduction.

Further if you’re self-employed and don’t have a regular income, fixing your loan may help you manage your cashflow.

If you do decide to fix your loan, it may be sensible to fix only a portion of it and put the rest of your borrowings in a separate variable loan facility. The usual split is 50 per cent fixed and 50 per cent variable, though this isn’t set in stone.

Splitting your borrowings enables you to make unlimited additional repayments on the variable component so you can reduce debt more quickly.

In the end, deciding to fix your loan comes down to your personal situation, how much debt you have and whether you think that obtaining certainty in your repayments is worth the risk of paying a premium if the official interest rate falls. Even if your friends or family are fixing their loans, it might not necessarily be the right move for you.

Mark Armstrong is a director of Property Planning Australia (NSW), www.propertyplanning.com.au  

Tags: banks, economy, finance, interest, investment, rates, real estate

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