Ask Paul: Interest rates are at an all-time low but we're stuck in a fixed rate

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Hi Paul,

My family and I bought and moved to our new Gold Coast home in April 2018. Our mortgage is $585,000 and we have a five-year fixed-interest rate
of 4.45%.

We decided to go with a fixed-rate loan, thinking on the safe side that if interest rates go up we would still be paying the same weekly repayments (around $671 a week).

paul clitheroe

We both make extra repayments. My wife contributes $200 fortnightly while I contribute $75 weekly. I paid off my $10,000 car loan about three months ago so the only debt I have is our mortgage.

Two years later - and because of the current pandemic - interest rates have fallen everywhere (to a low rate of 2.27% on a three-year fixed term). 

Thankfully, my wife and I are still working full time. We tried to negotiate with my lender but sadly they declined our request, informing us that under the contract we need to finish the term, which has three more years remaining.

My question is, will it still be worth making extra repayments even though our home loan fixed rate is still high?

I am thinking of stopping our extra repayments and saving the money, and once we renew our loan term in three years and get a lower fixed rate, that will be the time to make extra repayments. When the term ends, is it also worth going with another fixed-rate term or switching to variable? - Victor

I am sorry to hear you are locked into the higher rate, Victor, but you did the right thing talking to your lender. Do check what the penalty is in your contract. It may be so high that it makes no sense to change, but bank contracts do vary.

What you also need to know is how your extra payments are treated. Is the extra money reducing the size of your loan and hence the amount of interest you pay? If so, it would be a no-brainer, as effectively earning 4.45% tax free on any savings or extra repayments would be great. Check with your bank.

Once you understand the conditions around extra repayments, you can make a call. But in a worst-case scenario, I agree, keep on saving so you can reduce the size of your mortgage in three years.

For about 40 years I have been advising people to avoid fixed-rate mortgages.

I got this wrong in the late 1980s as interest rates soared, but since 1990
it has been a one-way street with falling rates. I suspect my preference in three years will be to go with the lowest-cost variable loan you can get.

But as we sit here in the middle of a pandemic, I'm going to reserve judgement. But I'd love you to drop me a note in three years and we can revisit the issue.

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Paul Clitheroe AM is founder and editorial adviser of Money magazine. He is one of Australia's leading financial voices, responsible for bringing financial insight to Australians through personal finance books, the television show Money, radio, and most notably this publication, which he established in 1999. Paul is the chair of the Australian Government Financial Literacy Board and is Chairman of InvestSMART Financial Services. He is the chair of Financial Literacy at Macquarie University where he is also a Professor with the School of Business and Economics. Click here to email Paul your money question. Unfortunately Paul cannot respond to questions posted in the comments section. Please view our disclaimer here.
Comments
Daniel Rice
July 20, 2020 8.56am

G'day Victor, your bank does not sound helpful. If you find your "break" cost which is the payment required to leave your current fixed interest loan, you will then be able to determine if it is worth exiting your current fixed loan.

As an example my family just paid slightly over 10k break cost to exit our fixed interest loan and we will make this back in interest payments in 18months with our new rate (our fixed rate was lower than your current rate).

If your bank is being obstructive, give 'em the flick. There are plenty of lenders out there that will work with you.