Let’s recap the previous blogs on this topic:
- Any fixed rate offered by a funder includes the pricing in of the funder’s expectation of the cost of providing the finance over that fixed period. This includes the funder’s cost of capital, i.e. profit margin, and the additional risk pricing premium for the funder carrying the risk of any unexpected increases in the cost of it providing the finance.
- A funder of repute is obviously much better at forecasting the particular cost to it of providing finance over any period than an average home owner.
- As such, fixing a rate only really safeguards a home owner from increases in the cost of providing finance over that fixed period that the funder hasn’t already priced in.
- From a consensus Shariah perspective, there is no doubt that – per AAOIFI – variable rates (for Ijarah) are as permissible as fixed rates (for Ijarah).
Question: what are the implications of the foregoing to an average homeowner’s fixed rate vs variable decision?
Answer: The decision becomes one based predominantly on individual home owner preference, rather than on external factors.
In very simple terms, a funder calculates the cost impact of an input event variable as [(probability of event) x (cost impact of event)].
The distinctive advantages that the home owner has of a fixed rate over a variable rate:
- Knowing exactly what her/his/their payment obligation is over that fixed period (whether its 1 year, 5 years or 15 years).
- Protected from any unexpected increases in the cost to the funder of providing the finance over the fixed period.
- Can make extra payments and sometimes enjoy an offset facility if redraw is available.
The disadvantages that that the home owner has a fixed rate over a variable rate:
- Not benefiting if rate decrease.
- Cannot make extra payments, otherwise break fee applies for making extra payments or if selling the property.
Home owners also can get a benefit from both fixed and variable rates by splitting the finance. For example: 50% fixed and 50% variable.
When making a decision to go fixed or not and how much to split, it’s recommended to consult your financial adviser in regards to this matter. As individuals’ finances, health circumstances and age can affect the advice.