What should I do when my fixed-rate loan term is ending?

If your fixed-rate loan is coming to an end there are four key options to consider. We weigh up the pros and cons of each, look at who they may suit and outline what to consider.

Australians have enjoyed a marathon run of record low rates, and the past two years have seen plenty of savvy homeowners lock into a fixed-rate loan. But as those fixed terms draw to an end, it’s worth carefully considering the next move.

As a guide to the scale of loans about to exit a fixed rate, $19 billion worth of Commonwealth Bank mortgages alone will reach the end of a fixed term by the end of June.

A further $25 billion will approach the end of a fixed term by late 2022. And throughout 2023, CommBank customers will collectively have almost $100 billion worth of mortgages rolling off fixed rates.

The challenge for these homeowners is that the interest rate environment is changing.

The Reserve Bank called time on its record low cash rate, with a 0.25% rate hike in May. That decision, coupled with a warning that this is the start of “normalising monetary conditions”, suggests we could see more rate rises in the not too distant future.

The impact coming off fixed rates may have on your repayments

For homeowners who have enjoyed the stability of a fixed rate, the end of a fixed term brings the need for key financial decisions.

As rates rise, it can also bring hip pocket pain. Just how much you feel the squeeze of a rate change depends on the rate you locked into – and when.

As our table below shows, borrowers who locked in for two years in mid-2020 would likely be paying an average rate of 2.27%. On a loan of $500,000, this means monthly repayments of $1,916. The average variable rate is expected to be sitting at around 2.89% in July. So transitioning to a variable rate is likely to lift repayments to $2,069 – an uptick of $153 each month.

The situation may be more challenging for those who locked in for three years at the start of 2020. These homeowners are paying an average rate of 2.98%. On a $500,000 loan the monthly repayments would be about $2,103. If we assume variable rates rise to 3.89% by early 2023, the same borrower may be up for an extra $231 in monthly repayments when their fixed term ends.

There could be a silver lining for homeowners who fixed for three years in mid-2019. Back then, none of us had even heard of COVID-19. The Reserve Bank’s cash rate was a lot higher at 1.0% and the average three-year fixed rate was 3.77%. So while these homeowners have been paying a higher rate for several years, they are likely to pocket savings of up to $223 each month on loan repayments when their fixed rate expires. This assumes an average variable rate of 2.89% by mid-2022.

The impact coming off fixed rates may have on your repayments

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Source: www.canstar.com.au – 12/05/2022. Average rates based on the lowest rate for each major bank for an owner occupier borrower, available for $500,000, 80% LVR and principal & interest repayments. Future rates based on the current average lowest variable rate from the major banks (2.24%) with increases as per the May cash rate increase of 0.25% and Westpac’s cash rate forecasts (4/05/2022). Westpac’s cash rate forecasts are as follows: Jun–22: 0.40%, 4x 0.25 percentage point increases from Jul-22 to Dec-22, 2x 0.25 percentage point increases from Feb-22 to Jun-23. Loan calculations based on a $500,000 loan repaid over a total of 30 years using principal & interest repayments.

All these different possibilities highlight that there is no one-size-fits-all approach for homeowners nearing the end of a fixed term. There are four key options available and it’s worth knowing the pros and cons of each.

1. Stick to the variable rate on your current loan

This ‘do nothing’ option means staying with the same lender, and having your loan revert to the standard variable rate once the fixed term expires.

Pros

The appealing aspect of this strategy is that it’s easy. If you’re pressed for time, or you’re not interested in taking further action, simply rolling over to a standard variable rate can tick the boxes for simplicity.

Cons

Your lender may have had a cracking fixed rate when you first locked in, but the current variable rate on offer may not be so compelling. This makes it essential to at least contact your lender in advance to know the variable rate you will be paying. This gives you an opportunity to check out other rates available in the market and think about whether refinancing may be a better solution.

Who this option may suit

Allowing your loan to roll over to a variable rate with the same lender can be a good idea if you are confident you will pay a competitive rate. You may also want to stay with the same lender if you have a package loan that provides worthwhile perks and savings on other financial products.

What to consider

You may want to be loyal to your lender, but chances are your lender won’t reward that loyalty with its market-leading rate. Reserve Bank data confirms that lenders typically reserve their best rates for new customers. So it’simportant to at least take a look at what’s available elsewhere. Big savings on loan interest could be up for grabs.

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2. Take out another fixed term

Locking in for several more years means you won’t have to worry about market rates rising further. But the boat may have sailed on ultra-low fixed rates.

Pros

It can make sense to fix your loan rate now that we’ve moved into an environment of rising interest rates. Fixed rates have ticked up in recent months. However, if you’re prepared to look beyond the big banks – and possibly your current lender – competitive deals are still available.

Cons

Make sure you aren’t missing out on any features you want by locking in. Fixed-rate home loans are becoming more flexible. Some now offer features such as fee-free extra repayments (though sometimes with annual limits), redraw and even linked offset accounts. Be sure to check out the features of a fixed loan – not just the rate – to ensure the loan is right for you.

Who this option may suit

If future rate hikes could hurt your budget, returning to a fixed rate will shelter you from increasing variable rates – though only for the fixed term. It may be a case of delaying the inevitable, and at some point, your household finances may need to be recalibrated to cope with the new reality of rising interest rates.

What to consider

Before jumping into another fixed rate, think carefully about what lies ahead. If you need to bail out of a fixed-rate loan because you sell your home or you want to refinance to access home equity, you are likely to be hit with break costs. These can be significant, especially in an environment of rising rates. So be quite sure that you’re happy to stay with the same loan for whatever fixed term you select.

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3. Split your loan between fixed and variable

Most lenders allow home loans to be split between fixed and variable rates – often in the proportions you choose. You may, for instance, decide to fix 60% of the loan, while leaving the remaining 40% variable.

Pros

Splitting your loan can provide the best of both worlds. The variable rate component gives you flexibility, while the fixed portion shelters part of your loan from rising interest rates.

Cons

Enjoying the best of both worlds also means putting up with the downsides. The chief drawback of splitting is that if variable rates fall, you won’t pocket the full savings on the fixed portion of your loan.

Who this option may suit

Splitting could be a handy strategy for you if you’re struggling to decide between a variable rate or fixed rate, or if you’re keen on a combination of flexibility plus rate certainty.

What to consider

While most lenders offer split loans, it’s an option that may not be available for every type of loan. So you could have a smaller range of mortgages to choose from.

Where splitting is available, be sure to ask about the loan fees. From the lender’s perspective, a split loan is seen as two separate mortgages, and you could end up paying two sets of fees at the start of the arrangement.

4. Refinance

Whenever interest rates swing in a new direction, it’s generally a cue for homeowners to review their loan. Moreover, if you’re coming off a fixed rate, it’s likely you’ve had the same home loan for several years, and it may be time to see how your loan stacks up against the broader market. You may consider switching lenders if you find a better deal. Also, you may want to take advantage of a cashback deal that may help offset the costs of refinancing. Just be sure you’re not paying a higher rate just to get the cash back.

Pros

Refinancing can be an opportunity to score a better rate. Reserve Bank figures show that in March the average variable rate on outstanding loans was 2.89%. That’s 0.43 percentage points higher than the average of 2.46% across new loans written in the month. You could potentially do even better.

Cons

Your circumstances may have changed since you took out your current loan, and this has the potential to impact your borrowing power.

As a guide, a homeowner earning an annual income of around $91,000 could have their borrowing power reduced by up to $64,000 just by having a credit card with a $10,000 limit. Having a car loan for $30,000 could knock $101,000 off the same homeowner’s borrowing limit. Even having a child can trim borrowing capacity by around $55,000.

On the flip side, you may be earning more compared to when you fixed your loan rate. The only way to know for sure how much you can borrow is to speak to a lender or mortgage broker.

Your borrowing capacity matters because many of the lowest rates for refinancers only apply if you borrow between 60%-80% of your home’s market value. That means having 20%-40% equity in your home.

The deal breaker can be having less than 20% equity. Where that’s the case, you will be asked to pay lenders mortgage insurance if you refinance to a new loan. This cost, which can easily top $10,000, has the potential to wipe out the savings of a lower rate.

Who this option may suit

Refinancing can work best if you have plenty of home equity, few other debts and a sufficient income to meet the serviceability requirements of low-rate lenders.

What to consider

Refinancing does come with costs. This can include application fees on the new loan and mortgage discharge fees on the old loan.

These expenses make it sensible to work out how quickly the savings of refinancing will let you recoup the costs. For instance, if it costs $1,000 to refinance, but you’re saving $200 each month on loan repayments, you’ll be in front in just five months.

The faster you can cover the costs, the better. As living costs rise, it pays to have savings in your pocket sooner rather than later.

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