Switching From Fixed Rate To Variable Rate

By Sandy Naidu | April 24, 2009

Interest rates are falling and the chances of Reserve Bank further reducing the rates are high. People with home loans are quite happy - well at least the people with a standard variable rate loans. Those with fixed interest loans unfortunately have not been able to reap the rewards of the recent rate drops. It was not long ago (as early as beginning of last year), pundits were recommending a move to fixed interest loans - or at least split loans. And today the market scenario seems to be totally different.

If you are locked into a fixed rate loan and are considering moving it to a standard loan then here are the few points you will have to base your decision on:

Break Fees

There will be a huge break fee when you break the fixed rate contract with your lender. Most often the break fees will outweigh any money that you can save by moving to a standard variable rate. Standard variable home loans are largely funded by deposits by savers. Fixed rate loans are largely funded by lenders accessing wholesale funding. The rates for this funding will be locked in at the start. Hence when you are breaking away from a fixed rate home loan, the lender will have to be compensated for the loss of interest money. This compensation is the break fee.

The first thing you need to do is to contact your lender and ask them what the break fees are. Ask them to provide this in writing. You will usually get a letter mentioning the break fees in 5 to 7 days. The letter will also have an expiry date. So if you don’t move before this date then the break fees will change.

The calculation method for this break fees is quite complex and the lenders usually don’t share the formula with you. But here are the basic things the break fees will depend on:

1. The remaining term of your loan. The longer term remaining then higher the break fees.
2. The current fixed loan rates versus your fixed rate (basically if the chances of further rate cuts are high then break fees are high).

New Standard Variable Rate

Research and determine whom your next loan is going to be with and what the features of this new loan are. Find out if you can include the break fees in the new loan (you are borrowing to pay break fees).

Compare The Two Loans

Find out how much you will have to pay over a 3 to 5 year period if you are stuck with your fixed rate loan. Now find out the same with the new standard variable rate loan. The savings has to be much higher than break fees. Otherwise the move is not worth it.

Research and make decision with a calm head. The decision will be different every one - it all depends on the current loan the individual has. If you had to make this decision with your loan, share your ideas/opinions/thoughts with us.