Use a Fixed or Variable Interest Rate on Your Investment Loan?

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With most mortgages, you can choose whether you want to use a variable interest rate or a fixed interest rate.  The variable interest rate is usually a bit cheaper up front and it will change each time the official cash rate changes.

A fixed interest rate on the other hand is a rate that your financial institution offers you that will not change over the agreed period of time.

For example, for the same investment loan, the bank may offer you 7% variable interest rate or alternatively, a fixed interest rate of 7.3% over 3 years.

Which Should You Choose?

This is a difficult question to answer because unless you can predict the future of your country’s economy, you simply do not know how interest rates will fluctuate.

The 7% rate is obviously better in the short term, assuming that interest rates don’t increase too fast in the near future.

The 7.3% fixed rate is more expensive in the short term, but if variable rates increase to 8% in the next 12 months, it starts looking like a better choice.

It’s easy to say that in hindsight though.  The fact is, if everybody is predicting that rates are going to increase significantly in the next year, the banks will most likely have already factored that into fixed rate offers.

The Solution

Instead of relying on having psychic powers to predict the future of interest rates, instead look at your personal financial situation.

You need to work out, based on your current investment properties (if any) and the current mortgage you are applying for, what is the maximum interest rate on those loans where you can still comfortably afford the repayments?

If there is not much room for interest rates to go up, before you start becoming financially stressed, it may be a good idea to choose a fixed rate for a short period of time.  I would recommend no longer than 2 years but it will depend on your circumstances.

The point here is that you can use a fixed interest rate to help mitigate the risk of interest rates becoming too high for you to afford the repayments.  Because if you start missing repayments, then the bank starts to look at defaulting you on your loan which is the worst possible situation you can face with a mortgage.

If it gets to this stage, the bank can legally sell your property without your permission, take the money that they are owed (plus any costs associated with the sale) and then if there happens to be any money left over, pay it out to you.

In conclusion, you can use fixed rates to help protect yourself from financial pressure, but if you can easily afford a spike in interest rates of 2 or 3%, you are probably better off sticking with a variable rate.


 

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