The Australian economy is currently facing many challenges. Pandemics, wars, inflation, and an uncertain future for interest rates are causing many Melbourne property investors to consider their options. Will a fixed interest rate save your property investment, or are you better off sticking with a variable rate? Keep reading to find out.

What’s Happening with Interest Rates?

Low-interest rates for housing loans have been a safe bet for at least the last decade, but that is changing. On May 4, 2022, the Reserve Bank of Australia (RBA) lifted interest rates from 0.10% to 0.35%. So naturally, the banks didn’t waste any time passing the extra costs onto their customers by adjusting their home and investment loan rates. 

So, why does the RBA raise rates? The cash rate is a tool the RBA uses to promote economic growth, influence employment levels, and hit inflation targets. The global economy has been turbulent, and our big island nation isn’t immune to its influence. The current range of strife has created economic conditions ripe for inflation, so the RBA has felt it prudent to curb it by introducing higher interest rates.

Controlling inflation promotes stability and prevents uncontrollable spikes in prices for goods and services. Rising interest rates have the opposite effect on inflation by curbing price rises on goods and services. Higher mortgage payments for property investors and homeowners limit the amount of cash floating around in the economy, leaving fewer available funds to pay for goods and services.

Demand is reduced, and, as you know, reduced demand equates to lower prices, but the economy is a complicated beast. Easing up on one sector of the economy always puts strain on another. Higher interest rates mean increased mortgage costs and force homeowners to reign in their spending.

Fixed Rate Home Loans – The Positives

A fixed rate home loan is not affected by the interest rate market during the fixed rate period. Borrowers can select to lock in a rate for one year or up to 5.  

You always know what your payments will be during the term, making it easier to budget for your property investment from month to month. 

Fixed Rate Home Loans – The Negatives

Banks never miss out on making a profit, so the longer you lock your home loan down with a fixed interest rate, the more you will pay in interest. So if you are considering taking advantage of current low rates, expect to spend a few more percentages for the privilege of certainty. 

And plan to keep the property for the entire term because significant fixed rate break costs are attached to an early exit. You may be in front for a while, but the early payout fees can quickly consume any capital gains when it comes time to sell. 

You may also feel good about getting in front when interest rates push up higher than your fixed rate, but imagine the position of Melbourne investors locked in at 4% when rates suddenly dipped to less than 1% and continued to fall. 

Variable Rate Home Loans – The Positives

Variable home loans are linked to the current cash rate. When interest rates go down, banks adjust their rates downwards accordingly. 

A variable rate mortgage is more flexible than a fixed rate because you aren’t penalised for making extra payments. When rates drop, you can keep paying the same amount, effectively reducing the interest you will have to pay. 

Most banks will offer extra features with variable rate loans, such as an offset sub-account that pays interest earned directly into the mortgage. 

Variable Rate Home Loans – The Negatives

Unlike fixed-rate home loans, variable rates can make budgeting unpredictable when the cash rate starts to rise like it’s doing now. A Melbourne investor with a property investment portfolio of 3 or 4 houses could see their budget stretched to breaking. Fortunately, tax advantages can help ease the strain. 

Let the Numbers Be Your Guide

Whether variable or fixed interest rates will work in your favour will depend on your situation, so pay attention to:

  • How much will your payments change when the cash rate changes?
  • What amount of interest are you paying?
  • How much will it cost for an early payout on a fixed-rate mortgage?
  • What is the payment difference between fixed or variable

Every investor’s situation will be unique, so working out your costs when considering variable versus fixed is to check your numbers. 

Heritage has a loan calculator, so let’s look at a couple of scenarios: 

Fixed Rate For Five Years At 5.19%

Your Savings / Deposit: $100,000

Application Fee:- $0

Stamp Duty: – $20,025

Up Front Costs:- $0

Available Deposit: $79,975

Property Price: $600,000

Loan Amount: $520,025

Fortnightly Payment: $1,551

Variable rate at 2.94%

Your Savings / Deposit: $100,000

Application Fee: – $600

Stamp Duty: – $20,025

Up Front Costs: – $0

Available Deposit: $79,375

Property Price: $600,000

Loan Amount: $520,625

Fortnightly Payment: $1,226

The payment difference per fortnight is $325, a significant saving over a fixed rate. The savings are even more valuable for a Melbourne property investor with multiple properties.

Of course, interest rates could continue to rise, but you will need a few rate increases before closing the gap. We suggest our clients hedge their bets by calculating the fixed rate versus the variable and depositing the difference into your mortgage account. Then, when interest rates do rise, you will have a nice buffer, and you will already be used to paying the extra amount. 

Can’t Decide Between a Fixed Rate Loan or Variable Rate? Consider a Split Loan

If you can’t decide between variable or fixed, you will be pleased to know that you can do both. For example, say you go for the $600,000 mortgage, and you split it evenly into $300,000 for each. 

The variable portion is treated as a standard variable loan so that you can make extra repayments without penalty. The fixed-rate provides the security of a regular monthly repayment that won’t change with the cash rate. If cash rates rise, you’ll only be paying half of what you would be if the loan were fully variable.

Getting into property investment in Melbourne can be a complex task. Get in touch today for the best advice and ideas on the most profitable strategies.