As a finance broker I am frequently asked: What’s the best? To be honest, that depends on your individual circumstances and what you are trying to do. However, I think there is some misinformation out there about this months topic and I would like to expand on it in the hopes it will give you something to think about the next time you review your lending.

 

First, most people with non tax deductible debt will opt for a P&I loan so they reduce the loan amount over time. Likewise, those with tax deductible debt tend to go for the Interest Only loan, citing tax deductibility as the reason. Neither is more right or wrong than the other. But here is a slightly different way to look at.

 

That’s what you do when you chose an Interest Only loan. You keep control of WHEN you make principle reductions. One advantage of this strategy is that it will improve your cash flow because your monthly payment will be lower. However, if you didn’t make any principle reductions you run the risk of not reducing your mortgage at all.

 

Who does this type of strategy suit? I would say it suits those with good disposable income allowing you to put extra money each month towards the mortgage. In doing so you effectively would use your mortgage account as a Savings Account. In that case you are better off putting the money in the mortgage because you won’t pay tax on the funds in the mortgage account as you would if they were sitting in a bank account. You can of course utilize an offset account with an interest only loan as well.
If you have problems budgeting or are not able to save then this idea probably isn’t for you.

 

So is a fixed or variable mortgage better? My response is dictated by what I believe will happen to the price of money. What does that mean? Interest rates are really determined by the international cost of capital generally set in and by the bond markets (these are the guys that really lend the money). Despite what the RBA sets interest rates at it is often the activity in the global bond market that sets rates here.  The bond markets are huge, much larger than the stock market and only smaller than the currency markets (we’re talking trillions here). So if we have a debt crisis (like the one currently happening in Europe and the US) we often see volatility in interest rates. So far this hasn’t affected Australia too much but I don’t know what might happen should there be a default by a major nation.

 

At the moment I believe that a mix of fixed vs variable is good (maybe a 60/40 split) with a 3yr fixed term. I think there is currently more risk of rates going up than down and you can currently get a fixed rate that is lower than the variable rates. By choosing a split you maintain some flexibility as to which debt you pay off as well as the ability to make extra repayments.

 

Remember, it is best to review your mortgage every 1-3 years to ensure it’s setup in the most appropriate way for you and your family.