To Fix or Not to Fix
Updated: May 17
It was 2007. I was working at one of the major private banks in their wealth management arm. I decided to fix my mortgage. Why wouldn't I? The RBA cash rate was about 6.25%, the economy was booming, and rates were only going to go higher. I was working in the industry, I would know what's going on. I fixed my mortgage in at 7.50% for 3 years. It was June of 2007 to be precise. Little did I know of the hairline cracks that were appearing in the global economy. Rates continued to climb for 1 full year subsequently and hit 7.25% in April of 2008. In fact, variable rates at this time were 9.44%. Fixed rates at that time were 8.97%. Look at me. I was a genius. Well above the average investor.
Do you know what was going on at the time? Do you know what happened subsequently? The RBA cut the cash rate from 7.25% to 3% in 8 months. We were well and truly in the depths of the GFC.
Rates would rise again from 3% in 2009 to 4.75% in 2011, to only fall again from 4.75% to 0.10% until the most recent rate hike of 0.25% - bringing the RBA cash rate to 0.35%.
I've been getting a lot of questions around rates - should I fix my rate? Is now a good time to fix rates? Going by my track record, I am the worst person to ask these questions. But let's take a look at the data. I went into the archives and looked into variable and fixed rates since 2000, as well as the value of fixed rate loans during this time to give me an idea of the value of loans that were being fixed.
And so here it is - Australian fixed rates, versus variable rates, and the value of fixed rate loans.
The takeaways for me are, 1) fixed and variable rates following each other quite closely up until about 2012, when fixed rates were constantly lower than variable rates, 2) the recent rise in fixed rates has given a lot of that up, and 3) borrowers seem to rush to fix their loan at precisely the wrong time - note the jump in the blue line each time there is a rise in rates, a classic head fake.
So what does all of this mean anyway. I decided to run a few scenarios and crunch the numbers.
Let's start with this fact - the average variable rate since 2000 is 6.45%, and the average fixed rate is 5.75%. Although I think the last few years have dragged this average down quite a bit, as you can see in the chart above.
If you had fixed your loan at the beginning of the year 2000, and continued to roll your fixed rate every 3 years, here is the total interest you would have paid on a $1m loan:
By fixing your loan you would have saved around $143,525, or about $6,500 pa in interest. There is no reason why I have used the year 2000 as the start date. The common base data goes a little further than this, back as far as 1991. I thought I would use the turn of the century. Even if you go back further, the average variable rate is 7.31%, and fixed is 6.87%.
Let's say you were super smart. And you decided to fix in your loan when the RBA first raised rates. Your first fix would be in February of 2000. You would continue your fixed rate for 3 years. You would switch your loan to variable as rates were not rising. You fix again in November of 2003 after the RBA's first rate hike. You roll this fixed rate at maturity as the RBA hiked rates again in October of 2006. The same thing happens at the maturity of this fixed rate on October 2009. At the maturity of this loan, your loan converts to variable as the RBA were not raising rates, they we're cutting. In fact, were cutting right up until May of 2022. Under this "smart money" scenario, here are the total interest costs:
Smart Money: $1,457,945
Variable Only: $1,445,131.67
Under this scenario, the so called smart money moves meant that you were worse of by around $12,813.33 over this time, or about $1,067 pa.
Let's take the other side of smart money. Let's say you buggered every move, and that you fixed at precisely the wrong time. In this scenario, you fix when the RBA cash rate peaks. You fixed your loan in January of 2001, August of 2008, and October of 2011. Here are the total interest costs:
Dumb Money: $1,463,715
Variable Only: $1,445,131.67
Under this scenario you were worse off by around $18,583.33 over the period. In other words, around $844 worse off each year.
The difference between smart money and dumb money is about $1,000 each year better off or worse off. The challenge here is trying to pick the peaks/troughs in the rates. There isn't much of a difference in my opinion, for all the paperwork that comes with it, let along the decision of should I fix now?
Fixing your loan from the beginning of the data set is the clear winner. In fact, I went further and tested if this was caused by rate differences early on in the data set or later on in the data, and I could not find any difference. The fixed was ahead each and every time, and by at least $100,000 over the period.
Having said all of this, once you add discounted rates into the equation, it's a game changer. The average variable rate goes from 6.45% down to 5.87%.
If you had fixed your loans from 2000 as per the initial scenario, under a discounted rate, your $143,525 saving has eroded to only $14,175 or $644 pa.
Under the smart money scenario, your $12,813.33 worse off position blew out to -$65,800 or -$5,483 pa worse off. Under the dumb money scenario, your -$18,583.33 worse off scenario blows out to -$62,045 or -$2,820 pa.
There is no clear winner, as you can see above. Even if you pick the right time, the gains are marginal. The market is smart. Banks are smart. Fixed rates price in numerous factors to determine the rate. To think one can outsmart the entire market I think is foolish. Brave, but foolish. The odds are against you. I think it all boils down to what you need personally for you and your situation. There is no one size fits all.
My colleague Matt Rigby and I talk more about this in last week's The Wide Lens podcast.
You can also listen to the podcast on Spotify or wherever else you listen to your podcasts.