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I was recently having a conversation with a first home buyer who was about to settle on his mortgage and was looking for advice on appropriate loan structures. I asked what sort of advice he had got at this stage. When he asked his bank’s mobile mortgage manager about loan structure he was directed to his bank website and told to look at his options there. This is an interesting indication on the level of advice banks are now offering. From his family and friends he received various opinions including to structure it as a revolving credit or having it all fixed for ‘certainty’.

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In my opinion the very worst thing you can do with a personal residential mortgage is take a single fixed loan, especially in this economic environment.  I compare taking a fixed rate loan to taking up smoking; it is of absolutely no benefit to you, forms a bad habit and is of huge financial benefit to the whoever is providing the product. ‘But it offers certainty’ is the popular reason for taking it, that it does. It commits you to only making minimum monthly payments, which sets you down the path of a 25 or 30 year mortgage. A properly structured home loan should be paid off in 17-20 years not 25-30 years. The cost of these extra years on a $250,000 mortgage will be $125,000 – $185,000, or the ‘cost of certainty ‘.

In addition currently a fixed term of 2 or more years is around 1.5%-3% higher than the floating at this point in time so it is prohibitively more costly. On a $250,000 loan this means monthly repayments of $247-$490 per month greater than the current floating rate.

Even historically, where fixed rate loans have been significantly lower than the floating interest rate, it still makes little sense to fix you entire loan. As all you are doing is handicapping your ability to utilise your income to reduce your interest costs and penalising you for making potential lump sum payments.

I am not saying a fixed rate loan should be avoided in its entirety, however at best it should only be a component of your loan structure. So what do I mean by component? The size of any fixed rate loan should always be determined by how long you wish to fix for and then compared to how much you can reduce your loan by during that time, which means it needs to be personalised to your situation. I suspect those that encourage you to fix your loan for certainty are least likely to spend the time to help personalise a loan structure.