To fix or not to fix, the answer is not what you think

Anyone with a mortgage or about to get one might think variable rates offer the best chance to take advantage of an expected falling cash rate. But fixing now might be a smarter option.

While many mortgage-holders might think sticking with a variable loan in a falling rate market is appropriate, that may not be the best solution.

After 13 Reserve Bank cash rate increases since early 2022, mortgage holders who have been patiently waiting for a reduction in their interest rate may finally receive good news this month as we appear to be on the cusp of an RBA cut.

Easing inflation data led the sharemarket to bring in its forecast of a February RBA rate cut from 70 per cent probability to 95 per cent in recent days.

Although mortgage holders with variable interest rate loans will rejoice, it also marks the turning of the tide for retirees who have been enjoying a purple patch of high interest on their cash and bond investments.

With this in mind, as we get ready to cross over the interest rate peak and start to descend into the downwards cash rate cycle of the RBA, what should mortgage holders and cash investors be doing to prepare for this?

For anyone with a mortgage or thinking about getting one, the obvious answer is to keep your mortgage on a variable rate and benefit from the falling cash rate, as there are three to four rate cuts expected this calendar year.

However, Caxton Pang from mortgage broking firm Capton Finance says: “At the moment mortgage holders can enjoy an instant rate cut if they move their variable rate loan to a fixed-rate loan, with interest rates on offer being as low as 5.55 per cent fixed for two years – versus 6.15 per cent for a variable rate home loan.”

If inflation rears its ugly head again and disrupts the expected schedule of RBA rate cuts, then fixing the interest rate on your home and investment loans would be a smart move and something that should not be totally dismissed right now.

This approach would suit conservative mortgage holders who want the certainty of repayments and are happy for a 0.6 per cent instant reduction in their interest rate, even though they might have ended up with a bigger reduction over time if they stayed on a variable rate.

Outside of property owners, there are other borrowers who will be impacted by falling interest rates.

Personal loans, car loans and novated leases are generally structured on fixed interest rates for the duration of the facility. If you are considering buying a car this year and funding it with debt, it may end up saving you hundreds, if not thousands in interest if you are patient and wait for the RBA rate cuts before you buy.

On the other side of the ledger we have retirees who have been enjoying the best interest rates on cash, term deposits and bonds in almost 15 years. Bank accounts have been overflowing with interest which has outweighed increases in electricity, insurance and food prices. But alas, things are about to change.

Currently, the best high-interest bank account and term deposit rates are 5.5 per cent but this is likely to fall to mid to high 4 per cent by the end of this calendar year. Inflation is currently 3.2 per cent and as the RBA starts to cut rates, the old problem of cash returns being similar to the inflation rate will start to re-emerge.

Although the $250,000 government guarantee on bank deposits is still in place, making cash deposits up to this amount effectively risk free, there will start to be an increasing number of retirees looking for other options to try to hang on to the high rates of income they are currently receiving.

One option is to look at Australian-listed real estate investment trusts (REITS) such as Garda Diversified Property Fund (ASX: GDF) or Charter Hall Long WALE REIT (ASX: CLW).

These ASX-listed investments own portfolios of properties; some target office buildings while others buy warehouses or retail property and all generally pay dividends between 5 to 8 per cent while some pay dividends of over 10 per cent.

REITS are also likely to do well from a capital growth perspective in a falling interest rate environment as investors move away from bonds and into REITS.

Staying in the cash and bond space, one of Australia’s biggest and oldest non-bank lenders in the commercial and residential short-term mortgage space, Balmain Commercial, has been doing a roaring trade. Its retail investment offering has had a 15 per cent increase in investor funds over the past 12 months to $1.5bn and its wholesale investment fund has increased in size by 27 per cent to $1.9bn.

“When interest rates started to go up in 2022, a large number of loans we held on our books had not matured and we called them sea anchors. However, these loans eventually matured and we lent the money out again at higher interest rates,” Balmain head Tom Sherston says.

“We are now at the other end of the spectrum where the current loan investments on our books are paying high interest rates and will keep doing so for the next 12 to 24 months until they mature.

“So for investors wanting to lock in the high interest rates at 8.5 per cent to 10.5 per cent, now is the time to be thinking about fixed rate loan investments.”

For the more conservative investor wanting to lock in interest rates, a government bond portfolio will provide lower income returns of around 4 per cent but can lock in interest rates for longer.

There are several ETFs such as Betashares Australian Government Bond ETF (ASX: AGVT) that are available to achieve a seven year-plus lock-in period on interest rates.

Whether you owe cash or own cash, the expected RBA rate cuts will impact everyone. Although nothing needs to be done today, as rates start to drop which could be as soon as a few weeks’ time, borrowers and investors should ideally have a plan and know how they are going to respond.

James Gerrard is principal and director of planning firm www.financialadvisor.com.au