IT can be difficult to know when, if any, is the right time to lock into a fixed rate on a mortgage. Get it right and it can save you thousands. If your timing is wrong, you could end up paying a lot more than you needed to.
I remember, a number of years ago, a friend of mine locked into a five-year fixed rate at 5.25%, because mortgage rates were increasing every other month by 0.50% and it got to the stage where another couple of increases would have spelled trouble, so she decided to switch to a fixed rate. She remembers her bank telling her at the time, it was a great idea, and was the right thing to do. She felt pleased her decision was being endorsed by them.
Two months later, interest rates began to tumble; had she stayed on the variable rate, her interest rate would have been about 2.5%.
So, the decision to move to a fixed rate didn’t turn out to be a good one for her, because if she held her nerve, and stayed on that variable rate, her monthly repayments would be €452 less than what they became. If rates stayed the same over the next five years she would have ended up paying c. €27,000 more in repayments in that period, because she switched to a fixed rate.
Of course, hindsight is a wonderful thing. Rates could have increased further, and she could have saved herself thousands by switching to a fixed rate. But how do you know what will happen? Uncertainty is understandable. You can be presented with all the data in the world, and all indications might be leading to an increase or decrease in rates, but what actually happens could be the opposite to what you were led to believe.
Which is why I’m a fan of the splitting your mortgage, into part fixed and part variable. You are hedging your bets by doing this, because if rates go up, only a portion, not all, of your monthly repayment will increase, and the impact is less severe. If rates decrease you will see your monthly payment reduce on the percentage that is at a variable rate.
When rates tumbled, my friend went back to her lender and said, she had switched to a fixed rate a couple of months earlier, something they had recommended she do, and because variable rates were now much lower, she would like to get out of her fixed rate and go back to a variable rate.
Not a problem, they said, but because you are breaking the fixed rate agreement, we are going to charge you an early exit penalty of €23,000.
She didn’t have that amount of money and if she had she wouldn’t have given it to them. She could have remortgaged with another lender and absorbed the €23,000 penalty by increasing the amount she borrowed, something a lot of people did. She chose not to, however, and those five years she said were the longest of her life. It killed her every month, when her mortgage repayment was debited from her account knowing she was paying €452 more than she could be, and she didn’t want to think of all the things she could be doing with that amount.
Thankfully if the same thing happened today, she wouldn’t have to suffer five years of torment, because she would be able to exit her high fixed rate at a very low, affordable exit penalty.
An EU rule - the Mortgage Credit Directive - came into effect last year, which has changed the way lenders have to calculate early exit penalties. Until then, lenders calculated penalties based on the money they would lose until the end of the mortgage term from not getting the higher rate of interest, which could be very high, especially if you wanted to exit early into the fixed rate period.
With this new EU directive, lenders can only charge an exit penalty based on what they would earn from keeping the mortgage funds on deposit. Because rates for money on deposit are so low, it means penalties end up being very low and, in some cases, nothing at all.
Many lenders have decreased their fixed rates recently and I would suggest that if anyone has fixed their rate in the past two or three years and still has a way to go before it expires, to review their options. Chances are good they are paying more than they need and they can switch to a new, lower fixed or variable rate with their existing lender, or indeed move to a new lender, without it costing them very much, if anything.
A client of mine was two years into a five-year fixed, but his lender had reduced their fixed rates twice in the past 12 months and he was able to move to a new fixed rate with a ZERO exit penalty; he saw his monthly repayment reduce by €68.
So, don’t wait for the phone call from your bank to tell you about this, it won’t come. Be proactive and find out what their fixed and variable rate offerings are and ask if you decided to break out of your fixed rate early, what penalty would apply. I think you are going to be pleasantly surprised with their answer.
Liam Croke is MD of Harmonics Financial Ltd,
based in Plassey. He can be contacted at firstname.lastname@example.org or www.harmonics.ie