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02 Jul 2022

Making Cents: To fix or re-fix that is the question

Making Cents: To fix or re-fix that is the question

With some quick calculations it is easier to see what to do next with your mortgage rate

Leo Varadkar has warned that interest rates are likely to increase in 2022 and we should prepare for that eventuality.

And I think people are beginning to take notice, because the biggest question that’s arriving in my inbox at the moment is from people whose mortgage is currently on a fixed rate but isn’t due to expire for another year or two.

They want to know, can and should they move to a new fixed rate before their existing one comes to an end.

They’re asking because one of the biggest concerns for people right now is around that potential rise in interest rates and the impact it could have on the cost of their mortgage.

Some are worried about whether they’ll be able to afford their mortgage repayment if rates do increase and others want to know, should they exit from their current fixed rate, pay the penalty, and move to a new lower rate now which protects them if rates do increase next year or even the year after.

If interest rates do rise, it will not only impact those on variable rates, but also those who are mid-way through a fixed rate. Whilst it won’t impact their rate and monthly repayment immediately, it will when they expire, and they could find themselves re-fixing at a much higher rate than they were previously on.

With inflation increasing month by the month, one way of curbing it, is increasing interest rates. It’s not something that’s likely to happen until the end of next year or sometime early in 2023, but who knows? It could happen sooner. But what we do know, is that it’s almost certain that interest rates are going up.

Either way, it’s a difficult decision to make unless you crunch the numbers, and the numbers you need to know are, what exit penalty you’ll pay, and what the new rate you’ll move to is. They are the knowns in the calculation, the unknown is what future rates might become, so you’ll have to make assumptions in that regard.

And that’s what I did recently for a gentleman who contacted me.
For context, he owes c. €450,000 and his 5-year fixed rate is due to mature in January 2023.

His current fixed rate was 3.35% but his lenders current 5-year fixed rate is 2.50%.

The penalty they were quoting him to exit out of his current fixed rate was c. €3,279.

The difference in monthly repayments from 3.35% to 2.50% was €195, so he’d recover the penalty in about 17 months, and the potential savings thereafter could be much more substantial than €195 per month, given the likelihood of an increase in rates.

So, I crunched some numbers for him so that we could compare what the impact would be and this is what I discovered.

Best Case
He moves now before his current fixed rate expires, pays the penalty, and fixes his mortgage for a further 5 years based on what his lender is currently offering i.e. 2.50%.

In this scenario, he ends up making total repayments amounting to €132,009.60


Next Best Case
He stays with his current fixed rate until maturity, and interest rates when he re-fixes are only a fraction higher i.e. .15% than what rate he was previously on.

In this instance, he ends up making total repayments amounting to €143,220.75.

Worst Case
He stays with his current fixed rate and moves to a new higher fixed rate at maturity which is 1% higher than his current rate.
In this instance, he ends up making repayments which total €151,808.79.

You can see that it makes sense for him to pay the penalty and move to a new lower fixed rate now.

And that’s because he’s €11,211.15 better off, if rates only increase by a very small amount, and he’s €19,799.19 better off, if there’s a 1% increase.

Once he saw the three scenarios put in front of him, it made the decision easier for him because there was that nagging doubt that if (a) rates didn’t go up significantly was it a waste paying that penalty and (b) if he didn’t move now and rates did go up significantly, the penalty might end up seeming very small, and he’d regret not having paid it.

And unless your run the numbers, it’s nearly impossible to decide what to do, and the outcome good or bad is based on luck rather than logic.

Once he saw the different outputs, it was an easy decision for him which is why paying the penalty now and fast forwarding his fixed rate renewal was what he ended up doing. But everyone will be different.

If the penalty was higher or the new offering for his lender were higher then perhaps the numbers would have told a different story.

Personally I don’t think rates are going to increase significantly in one fell swoop. I think any increases will be small and done so incrementally over time. So, I don’t see a sudden 1% rise. It will be more like a .25% and depending on what impact that has, you could see another .25% three or six months later and so on until things begin to stabilise.

But this is me just guessing and giving a personal opinion. There are smarter people than me, who are better placed to give a more informed point of view.

Summary
We know what’s coming and that’s higher borrowing costs and I would recommend anyone currently on a variable or an existing fixed rate to review their current rate and see:

Can it be improved and lowered? and also - Run a scenario that if rates did increase by 1% what impact would it have on their monthly repayment and would they be able to easily meet that extra cost and - If you are in a fixed rate, consider what the exit penalty is and what the savings you hope to make and how that new fixed rate and monthly repayment fit into your monthly cash flow and financial situation.

Once you know what that exit penalty is, you can run some best- and worst-case scenarios like I outlined earlier.

Because if you do, they might help answer some questions that have probably been on your mind recently.

Question
Liam, I have to give back a company car soon and buy one myself. Could you suggest a price range I should stick within to help me budget please? My gross salary is €50,000.

Answer
Your optimum purchase price is €19,531 and let me explain how I arrived at that number.

There is a great rule of thumb for buying a car and it’s called the 20-4-10 rule i.e. have a deposit of at least 20% of the purchase price, finance the car for no more than 4 years, and keep your total monthly expenses (not just your car repayments – insurance, maintenance, and tax costs as well) under 10% of your gross income.

Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at liam@harmonics.ie or harmonics.ie

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