Interest Rates

This is one curious difference between Canada and Australia. In Canada, the preference is often given to using fixed-term, fixed-rate interest rates on home loans, where-as in Australia the preference is to use variable rates. Banks in both countries seem to offer various incentives for the respective preferred interest model, either being a good reason for the preference, or a business decision in response to the preference. For example, in Canada several banks will offer an adjusted-fixed rate loan that will decrease as the variable rate drops, but won't increase until the term is over. This is favourable in the sense that you don't get a feeling of being ripped off if interest rates start dropping after you've "locked in" for 5 years. In Australia, the options favour keeping your loans on variable rate. For instance most banks will offer a package that includes a discount off the variable rate, and features such as offset accounts.

Offset accounts: If you're the kind of person that can squirrel away money, offset accounts are absolutely awesome. They are fully liquid accounts that are linked to your mortgage. Every $ you have in this account on the given day is considered in the interest calculation on your loan. It is like if you put all of your savings against the loan and were to redraw from the loan, except without any of the hassle. You can use the funds in the offset account as normal. The account itself earns no interest (then again what liquid account does these days) but it's effective interest is your loan interest rate, which remains equally effective as interest rates climb. What this effectively means is that if your mortgage rate is 6.5% p.a. the money in your offset account is effectively earning you 6.5% p.a. "tax free". Can you find a liquid bank account anywhere that can beat that?! Fortunately the ATO doesn't tax interest savings. Depending on your income level you would need to find a rate of 8.45% to 9.5% p.a. to earn equivalent taxable interest.

I personally keep a spreadsheet of all transactions made against our accounts and the loan so I can keep track of how much interest we are paying each month, and how much cash we are saving. This is made much easier because we put most of our daily expenses on a credit card and pay off the balance each month. (Leaving extra cash in our offset account until the end of the month.) The package we have that includes a rate discount and offset account, plus a few other perks, costs us $350/year. The offset account and rate discount save us over $10,000 a year. (A no brainer.)

Recent hot-topics with the Mrs. that always seem to pop up as interest rates rise include whether we should fix a portion of our loan or not. There was a steep drop-off in interest rates due to the GFC, and now interest rates are climbing back up. At first I was a bit concerned, but then I did the math, and modified my spreadsheet to verify the numbers to prove that it is far more likely to cost you money than it would save you money.

Best-case scenario: I went back and applied a locked-in fixed interest rate the day before rates started to climb. Granted in reality you can only *guess* when rates will go up, and how fast they will go up, but for this test I used best case actuals. Fixed interest rates for 1 year are lower than the variable, but still 0.3-0.35% higher than our discounted rate. That means you're looking for at least 2 rate rises before you start saving back the extra intrest you start paying as soon as you lock in. The rates get significantly higher if you want to opt into locking for longer periods. The major catches to consider here are that any discount and savings from offset accounts you have only apply to the *variable* portion of your loan. The first rate rise after the GFC occurred roughly 7 months ago, so I locked in the day before. After about 3 months the interest savings recovered the extra cost, and after 7 months I would have saved $300. I'd estimate that after the year we would have saved about $500.

Sounds ok? Ah, but hind-sight is 20/20. There's no way I could have known rates were going to go up when they did, and when they will go up again. So adjusting the model I locked the interest rate just 2 months prior to the rate rise. Lets say the reserve bank is considering a rise next week. Maybe it goes up, maybe not... Got to lock in because banks will start raising fixed rates before the reserve bank makes a decision if the banks think the cash rate is going up. We lock in, rates don't go up, but they start climbing 2 months later. Now the numbers change dramatically. Those two months we are paying at least $3 a day more in interest, after 7 months of rate climbs we still haven't recovered this back in interest savings, and after a year we'll be back on variable or locking in at a higher fixed rate. Fixed rates are *NOT* a mechanism to try and save money, they are a mechanism to ensure people can maintain a consistent budget over a period of time.

Locking in interest rates in Australia in an attempt to save money leaves you with a mentality of hoping rates go *up* to prove you hadn't wasted that money... That just sounds stupid. :)