If you put all of the Australian banking economists into a room and asked them to come to a consensus on interest rates the likelihood is you would not get one.
How then are us regular punters supposed to get it right when the time comes to make a decision on our own interest rate options ??
Like many such decisions in life, the answer is often not black and white but more than likely a shade of grey.
Having a split of both fixed rate debt and variable (or floating) rate debt is known as “hedging”. Corporate borrowers have been hedging for decades as a mechanism to reduce interest rate expense risk to their companies. For smaller borrowers the practice has only become more common over the last 5-10yrs
So what are the benefits in hedging a loan ?
If your loan is 100% floating or 100% fixed, it is essentially the same “all in” bet – except one is heads and one is tails. As with any all in bet, you can often be spectacularly right or spectacularly wrong. Further still you will likely not know the outcome of your decision for a number of years after rates have made their ultimate move up or down.
By having a component of both floating and fixed, ie hedging, you take out much of the downside to the unknown with interest rates. How so??
Lets assume a 50/50 split between floating and fixed……
#1 If rates fall you still participate with half of your debt by virtue of your floating component. Only the fixed component remains at the current level
#2 If rates climb you still have protection for half of your debt via the fixed component with only the floating component increasing
Whilst there are genuine reasons for taking a fully fixed or fully floating position, such decisions should always be made AFTER you have spoken to a finance specialist. In that regard our Finance Manager Mick Doyle is here to help.