Am I Locked In With Fixed Rates?
Updated: May 26, 2021
Fixed rate loans provide you with certainty of interest rates for the fixed period. Unlike variable rate loans, fixed rates don't change. Fixed rates are pretty sharp and will give you peace of mind in these uncertain times. However, there are a few things to consider before going down the fixed rate path including the risk of being locked in because of potentially high break costs.
Breaking a fixed rate loan early could result in some hefty break costs, especially when interest rates fall. The lender needs to borrow the money at the initial rate but if rates fall and you want out of the loan mid term then the lender is stuck with the funds borrowed at the original/higher rates. They can't pass this loan on to other customers so they seek compensation on the difference in the rates in the form of a break cost. This is roughly equal to the difference in rates times the value of the loan times the remaining fixed rate period.
For example, a $500,000 loan initially fixed at 2.29% but with rates dropping to 1.89% and 1 year remaining on the term will cost around $2,500 in additional break costs.
Note that this big penalty should only apply where the lender's borrowing rate has dropped during the loan term. If rates stay the same or rise, then there will be little or no early break penalty. In an environment where we are at rock bottom with regards to rates then entering into a fixed rate loan is not as risky as it might be if we expected rates to fall further.
The other thing to consider is that most lenders won't allow you have an offset account with a fixed rate loan and most have a cap on what extra repayments you can make. So if you plan to make extra repayments during the loan term then consider setting up a variable rate split loan so that you can still benefit from interest savings via early repayments.
Fixed rate loans can offer great savings but they can also cost you in the long run if you make the wrong decision. Talk to us so we can help you structure the right loan for your situation.