Fixing for one year or two: how to think about it
A shorter fix costs less today and asks you to roll the dice sooner. Here is the arithmetic behind that trade, and the question worth asking before you pick.
On this page
- What you are comparing
- Two rates, not two loans
- One-year and two-year rates
- 5.55% and 5.86%
- Gap
- 0.31 percentage points
- Cost of the gap
- $310 a year per $100,000
- What nobody knows
- the rate in twelve months
What you are actually choosing
A fixed term is a bet on where rates go next, and fixing does not remove that bet, it only decides when you place it. Fix for one year and you take the cheaper rate now, then accept whatever the market offers in twelve months. Fix for two and you pay a little more for the privilege of not thinking about it until the year after next.
Neither choice is clever, and anyone presenting one of them as obviously correct is forecasting. The honest framing is that you are buying certainty for a known price, and the only question is whether that price is worth it to you.
The arithmetic, which is smaller than you think
Start with the two rates the Reserve Bank publishes. In the latest B20 series the standard one-year rate is 5.55% and the standard two-year rate is 5.86%, a gap of 0.31 percentage points. The two-year rate is the higher one, and that difference is the whole price of not thinking about the refix for another twelve months.
Turn the gap into money by multiplying it by the loan. The 0.31 point gap costs $310 of extra interest in the first year on $100,000, about $1,240 on $400,000, about $2,325 on $750,000, and about $3,720 on $1,200,000. Those scale in a straight line, so any balance gives its own answer: the yearly cost is the loan multiplied by the gap.
The question that actually decides it
How stable is your income over the next two years? Someone on a salary they expect to hold can absorb a rate rise at refix time by adjusting spending. Someone whose income moves with contracts, commission or a business cannot, and for them the extra cost of a longer fix is buying something worth having.
That question decides this far more reliably than any view about where rates are heading, because you know the answer to it and nobody knows the other one.
What this calculation leaves out
Break fees, if you refinance or sell inside the fixed term. Fixing for longer increases the chance you will want out before the term ends, and the fee exists to make the lender indifferent to that.
Splitting. Nothing requires the whole loan to be on one term, and dividing it across two dates means only part of your borrowing reprices at any one time. That can be a better answer to rate uncertainty than picking the winning term.