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Fixed-rate

Borrowers Should be Cautious

Borrowers should be cautious about taking a fixed-rate home loan now.

The rush of borrowers towards fixed-rate loans at a time when official interest rates have started to fall has Australia’s credit ombudsman worried.

With one interest rate cut in the bag, the ombudsman has urged borrowers to carefully consider the implications of locking in a home loan rate, in particular, the possible ”break cost” if they discharge the loan early to refinance or sell.

Housing finance data released last week showed that fixed-rate loans jumped from 5.6 per cent of all loans in August to 7.9 per cent in September as unusually cheap fixed rates enticed borrowers.

The ombudsman, who handles complaints about non-bank lenders, says although fixed rates are often seen as a way of reducing the risk of rising interest rates, and borrowers should be aware that they may incur substantial break costs in a falling interest rate environment.

In the past, fixed-rate loans have resulted in a spike in complaints when variable rates later drop significantly and people try to refinance.

While exit fees have been banned on variable-rate loans, lenders can still charge break costs on a fixed-rate loan to recover the amount they’ll lose if the borrower leaves early.

If rates are falling and the financier has to re-lend the money at a lower rate, they’re entitled to recompense. The more rates fall, the higher the break cost. These break costs can and do sometimes run into tens of thousands of dollars.

They might be payable if the loan is refinanced or discharged within the fixed-rate period, possibly because the property is being sold; if additional funds are sought, which would require the existing loan to be discharged; and if a lump-sum repayment is made during the fixed-rate period (though some lenders allow you to prepay up to $10,000).

Before signing a contract, borrowers should seek advice on how any break costs would be calculated.

If you’re already on a fixed-rate loan and are thinking about refinancing, ask first for an indicative payout figure, making sure this includes any break cost. Remember that this payout figure might change if you don’t act straight away.

Those who fixed in August and September won’t have cause for regret yet. The typical fixed rate was 6.6 per cent to 7 per cent then and even after the recent rate cut the average big-four variable rate is 7.55 per cent – though some people qualify for discounts of 0.5 to one percentage points.

However, those who locked in about 8 per cent in November 2007, when fixed-rate loans hit a record 24 per cent of all borrowing, know how costly it can be if you need to break a loan early when rates are falling.

A year after they fixed, the global financial crisis hit and rates plummeted, sending break costs soaring.