Probably one of the most frequently asked questions is should I fix my mortgage or stay variable?
As many of you know, I have owned 28 properties over the past two and a half decades and rarely have I won the fixing game with the banks. Probably only twice that I can remember.
Today, In Australia, 90% of the mortgage market is on variable and my advice would be to follow this high percentage and stay variable. Lending institutions today benchmark all loans at an interest rate of 8%. Give yourself the 8% test. Does the investment still stack up for you? Can you still afford to make the repayments? Eight percent has been the average interest rate here in Australia since 1920. For this reason, I encourage you to do the 8% test on all your investments moving forward.
A good example of whether to fix or stay variable is this story about my girlfriend and I several years ago. We were attending the Melbourne Cup together and were discussing our loans. I had several mortgages that were hovering around the 9.5 – 10% interest rate. My girlfriend on the other hand had fixed in at 7.5% and was delighted with her decision. At the time I was envious and she was joyous.
Ironically, the First Prime Mortgages collapse had been brewing in the background for the past twelve months, and we were largely unaware of it here in Australia. That same Melbourne Cup day was my first recollection of the news hitting the Australian public. First Prime Mortgages collapse in America!
My girlfriend is also an accountant and we were discussing the collapse and the dynamics of this potential domino effect. Would there be ramifications of this collapse on our shores and around the world?
On the interest rate front, the upside for me was that interest rates would fall down to around 5.5% leaving the people who had fixed their interest rate shocked and surprised that interest rates could fall so drastically in such a short period of time. The following year at the Melbourne Cup my accountant friend was still at 7.5% and I was down at the 5.5% level.
The wholesale lending market contracted, resulting in the retail and commercial markets being affected. Money was scarce and the retail and commercial markets were forced to borrow from a smaller pool of wholesale funds. The flow on effect is, as always, when there is high demand and low supply interest rates go up and the credit criteria follows.
There are several different types of loans. Quite common in the residential investment market are ‘full doc’ loans, where the borrower will supply full loan documentation to the lender. This usually is in the form of group certificates,bank statements, payslips and other supporting documentation for serviceability.
For self-employed people, there are ‘Lo Doc’ loans, meaning you supply less documentation or the supporting evidence for serviceability. Often, part of a Lo Doc loan can be a letter from your accountant substantiating your income through the business.
I would treat a Lo Doc loan with the same view as a regular loan and stay away from fixing. Lo Doc loans can be slightly higher in interest from a standard loan by up to a few basis points. Today up to 70% of Australians are employed by small businesses and many find it easier to apply for loans under a Lo Doc status.
The virtual death of Lo Doc loans in 2010, with the introduction of the new credit laws, made borrowing difficult for this class of investor. This was fortunately short lived and overcome within a few years under the ‘know your customer legislation’ and it is now up to the lender or broker to be more factual about information supplied for loans for self-employed applicants.
In setting my formula for success, a big part of this is having the right finance. What I have learned is this: flexibility in credit is very important when investing. Locking yourself in can cause problems in the future and sometimes part of having the right finance is having the flexibility to move around when you wish.
I look at it as a form of insurance. Each product with each bank is different and finding the right product is important. This is another good reason why using a broker can be to your advantage. Therefore, in determining the fixing game, my advice is to stay flexible, stay variable, and ride the market.
Lynne Wilton, The Formula, A mentor’s guide to confident property investing