FIXED RATES - Don't wind up in a bind
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, Ombudsman Raj Venga 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.
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.
''Break costs can and do sometimes run into tens of thousands of dollars,'' Venga says.
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, Venga says.
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.
❏ Fixed-rate loans should be used for certainty not as a ''bet'' on interest rates.
❏ Break costs can be hefty if you exit early when rates are falling.
❏ Selling or refinancing may incur a break cost.
❏ Extra repayments or loan top-ups can also trigger break costs.
Read more: http://www.smh.com.au/money/borrowing/dont-wind-up-in-a-bind-20111115-1nfxi.html#ixzz1e1uVhGl6