The Strategic Upside of a Long Fix
For those with a long time horizon, fixing a mortgage rate for five years can be a powerful component of a cohesive financial strategy.
Financial Security and Stability: A primary advantage of a long-term fixed rate is the shielding effect it provides against fluctuating interest rates. If you foresee life changes that might decrease your income—such as starting a family or taking maternity leave—a fixed rate ensures financial security and offers peaceful cashflow.
Potential for Rate Advantage: While fixing for five years currently incurs a higher cost(0.5% more per year than short term)this commitment is a hedge against rising rates. For example, on an $800,000 mortgage, this difference equates to just over $50 more per week, or $3,000 to $4,000 annually. To truly gain, you would hope interest rates increase by 0.5% very quickly, or by approximately 1%, if after two years.
Navigating the Risks: The Break Fee Landscape
The principal risk associated with fixing long is the potential for significant break fees. Because a five-year commitment involves the bank calculating compensation based on the rate you are paying versus the current market rate(across the remaining term), these fees can range from minimal to substantial. I have seen them range from a few hundred dollars to tens of thousands.
Break fees are incurred in several situations:
• Selling the Property or switching banks: Break fees are charged even if you sell the home before the fixed term expires.
• Receiving Lump Sums: If you receive a significant inheritance, bonus, or other lump sum and wish to apply it directly to the fixed portion of your loan, the bank may charge a break fee.
• Structural Changes: If your lawyer or accountant advises a change to the entity that holds the loan—for example, shifting the ownership structure to a trust—changing the loan entity can also incur break fees. Fixing for five years means you are making a commitment that makes it less simple to change the structure of the loan.
• Rates drop: forecasting interest rates accurately is not possible. So even at times of consensus the world can surprise us. Fixing long does mean that you can not take advantage of rates dropping.
Mitigation Strategies for the Long-Term Fix
Thoughtful planning can significantly mitigate the risks associated with long-term commitments, ensuring you maximize flexibility without sacrificing the benefits of a fixed rate.
Employ Partial Fixing: If you anticipate receiving significant lump sums (such as annual bonuses or an inheritance) or simply want to retain some flexibility, the most prudent approach is to partially fix the loan. You can fix a portion of the loan for the longer term and keep the remainder on a short-term or variable rate. Collaborating with a good mortgage adviser(like us) can help determine the ideal percentage split.
Cashbacks: A new bank typically gives you cash to move to them, however they can ask for some or all of it back if you switch banks within the first three years. This means that on the third year most clients expect a bonus if the loan is mobile. In some sense a five year rate has that extra two years, where rates can go up enough to trump the cash bonus. If you want to fix for four years however than seriously think about the three.
Seek Professional Financial Advice: Before making a long-term commitment, it is essential to consult with a mortgage adviser who can assess your overall financial plan. This is particularly critical if you are selling your home, expecting lump sums, or if your accountant or lawyer may suggest a new trust or legal structure for your assets in the near future. Ensuring the initial structure is correct can prevent unforeseen break fees later.
