If you're one of the millions of Australians with a home loan or some other kind of debt, you're probably joining in the gigantic collective sigh of relief. With the official rate dropping to 4.25% this week, anyone paying interest is probably dancing the funky chicken in their kitchen right now. But before you take your impressive dance moves out onto the front yard to scare the neighbour's kids, spare a thought for all those poor people who fixed their loans at 9%. In fact, we should all have a minute's silence in respect for their pain.
Enough silence. Interest rates are a gamble. We always have to take the good with the bad. It is very easy in retrospect to castigate ourselves if we have locked ourselves into a fixed home loan, only to find that rates come crashing down to their lowest point in decades. One couple I know bought a house a year ago, and fixed their loan, knowing that with two small children, they would be on one income for at least three years. Thankfully, they borrowed within their means. They took a gamble, and while they are living on one income and making improvements to their house, a predictable home loan repayment was important to them. They couldn't afford rates to go any higher.
The lucky ones
My friend Jo took out a fixed home loan way back when interest rates were really low. She's still paying around 6% on her home loan. She's the other side of the coin. Some people got lucky on the gamble, fixed their loans at what turned out to be the bottom of the trough, and have spent the last few years sipping beer on their porch, smugly watching everyone else panic, and humming Kenny Roger's 'The Gambler'.
Temptation beckons
If you're locked into a rather unpleasant fixed home loan right now, with months or years to go before your term expires, you might be tempted to switch lenders. While it sounds like the solution you've been looking for, be warned. In recent times, lenders have been jacking up their fees associated with switching loans that are fixed, so you need to be very careful. Think about it. If they're not making as much out of borrowers by slugging them interest, they are going to be trying to recoup their losses in more creative ways. Creative is just another word for 'would you like fees with that?'
Some scary, scary maths
If you're tempted, first of all, work out how much interest you will be paying on your home loan. This can be a fairly approximate figure. I would take the amount you have outstanding, and work with that. First, drink two shots of vodka to prepare for the shock. If you have $200 000 left on your loan, and your interest rate is 9.5%, for example, then your approximate yearly interest at that rate would be $19 000. For those of you that are not smarter than a fifth grader, that's the amount outstanding, multiplied by the interest rate, and then divided by 100, or $200 000 multiplied by 9.5, then divided by 100. If you've never done that little equation before, it can come as an unpleasant shock. While the monthly amounts on your statement, in tiny print, can not seem so scary, when you see an approximate figure for what you're paying over the year just in interest, it can be enough for you to temporarily lose the faculty of speech. Even if you do not have a home loan, but you're carrying some other kind of debt, like a car loan or credit card debt, do this equation. It will put into real financial terms what you have been hiding from.
Making the big call
Now comes the big question. Contact your lender, and find out what fees and charges will be associated with breaking your loan agreement and switching to something more beneficial. Be prepared for some seriously painful wallet cramp. In fact, I suggest you take two ibuprofen as a precaution, and be sitting down before you make the call. This could hurt.
Decisions, decisions
If the fees and charges associated with switching either product or lender are palatable, and the interest rate of the new loan will save you considerably just in the first year, then feel comfortable to make the decision. Remember, it is impossible to tell exactly how low interest rates will go, so be prepared for future disappointment. You might want to forgo a fixed loan on your new home loan, and just settle for variable. You also might want to wait a few months (the Reserve Bank apparently doesn't hold another meeting until next February) just in case rates come down even lower. Or, if you're carrying a reasonably small debt, and you fixed your loan when rates were not at their peak, you might just be happy to take the good with the bad, and ride it out. If you're going to be paying that debt for twenty more years, and you've fixed it for a long time at a rate that isn't seriously uncomfortable, then this could be right for you.
Even if you don't have a home loan, the above advice might help you. If you've got personal loans, switching might be an option, but again, use caution and do your sums. It's no use saving yourself a few thousand in interest when you're going to end up paying it anyway in the form of fees and charges.
A loan is a tool, just like a bread knife or a blender
Loans are a tool. Always remember that a loan should work for you, not you for it. If you feel like you're only working to pay interest on debts, that can be a warning sign that you're in too deep. The Australian Securities and Investments Commission has further information on financial counseling in your area. If things are getting out of control, I urge you to contact them. It could be the first step towards getting control of your finances.
The Reserve Bank's decision is welcome news to borrowers. Now you can get back to busting all your funky chicken moves on the nature strip.