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In This Video:

00:44 How the interest rate system works
01:49 What the banks want you to do
03:14 Should you go for fix or variable rate?

Hi Daimien here from Integrity. Today were going to talk about whether to fix or not to fix. That is the question! So with Australian Interest Rates, right now interest rates are pretty low so people are often asking me, “Daimien, is it time to fix the interest rate?”

What we’ll cover in today’s discussion:

  • How the interest rate system works
  • What the bank wants you to do
  • The amount of effort banks go to determine their rates
  • Some important points to think about before deciding to fix or stay on a variable rate

The Banking System

A lot of people don’t understand how the banking system works. The Reserve Bank of Australia is setup to be independent from the government and it lends money to the banks. Banks also borrow money from overseas sources like China. Banks borrow that money on a variable rate.

The Government requires The Reserve Bank’s to keep inflation between 2 and 3%. If inflation is going up the reserved bank will put the interest rate up. The flow-on effect of this is that it will increase the amount of interest payable on mortgages, and so reduce the amount of money that mortgage holders have in their pocket. This, of course, applies to mortgage holders on the variable rate. When this happens, they spend less money and the economy is “de-stimulated”.

If the economy shows signs of slowing, The Reserve Bank will decrease the interest rate. That, in turn, will result in mortgage holders on variable rates having more spending money which they will use to stimulate the economy.

What the Bank wants you to do

This system is fantastic, but the point of it is that the bank you are with wants you to be on a rate which makes them money.

The bank prefers mortgage holders to go with a variable rate, because they can change it to make profit if the reserve bank or overseas suppliers change their rates. So if you choose to go with a fixed rate, the bank has to cover themselves in case of any changes.

How Banks Determine their Rates

You can actually work out what the banks expect to happen by the differences between the fixed and variable rate.

  • Fixed rate much higher than variable ⇒ reserve bank will put their variable rate up
  • Fixed rate the same or slightly higher ⇒ reserve bank will keep rates the same
  • Fixed rate slightly less than variable ⇒ reserve bank will drop the variable rate

Currently, interest rates are at their record lowest, and has been there for a long time. This tells us that the bank expect the interest rate to continue to drop. So does this mean you should fix or should you choose to go with the variable rate?

What Should You Do?

If you think you’re smarter than the banks, and you believe that the variable interest rate will actually go up, choose the fixed rate. At the end of the day though, the banks at the end of the day are out to make money.

So they want you on the variable rate, they don’t want you on the fixed rate, because this provides them with a level of security. If the fixed rate is lower than the variable the banks think that the variable’s coming down. When this happens, it may not be wise to go on the fixed rate.

However, there are still merits in choosing a fixed rate because of the insurance it offers you, especially with the fixed rate currently so low. You can fix your rate for up to 5 years, and then accurately calculate the amount of interest payable over that period of time. The allows you to ensure that your property will pay for itself (positively geared) over the next 5 years, and a good property investor knows that you can basically own as many positively geared properties as you like. On the other hand, if you chose a variable rate, you run the risk of underestimating the amount of interest payable if interest rates increase.

If you are looking to build a significant portfolio, then the 5 year fixed rate could be worthwhile as an insurance policy, but you should understand that you will most likely end up paying more money than if you chose variable.

That’s all I have to say about interest rates for today. I am looking forward to our next blog post.

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