HIRE and RENTAL

FEATURE
Interest Rates — Fixed
or Variable
Given the option of selecting
either a Fixed or Variable interest
rate, which would you
choose?
Your attitude would probably depend
upon your expectation of future movements
in interest rates. And who knows
just where they are heading? What appears
to be emerging lately is a body of
opinion supporting the likelihood of
continuing relatively high interest rates
for some considerable time to come.
There are several quite sophisticated
products involving interest rates in the
marketplace at present. In this article we
Date of
Interest Rate
Change
By Kevin Lane
Finance Investigations, Commonwealth Development Bank
Quoted Rate Pa
Fixed Variable
Rate * Rate
will consider only the option of choosing
between a fixed or variable interest
rate for a term loan.
Perhaps an appropriate place to start
might be to examine how interest rates
have moved in the recent past, and I will
relate to rates charged by the Commonwealth
Development Bank of Australia
(CDB), for loans to primary producers
and small businesses.
The CDB has been offering the option
of either fixed or variable term loan rates
since April 1988. The pattern since then
is shown in Table 1.
Effective Average Rate PA
(Assuming Debt Incurred
on Date of Interest Rate
Change)
Fixed variable #
7/4/88 14.75% 15.00% 14.75% 18.20%
1/6/88 15.50% 15.75% 15.50% 18.49%
3/8/88 16.00% 16.25% 16.00% 18.80%
2/11/88 16.50% 16.75% 16.50% 19.30%
4/1/89 17.00% 17.25% 17.00% 19.70%
1/3/89 18.25% 18.75% 18.25% 20.10%
7/6/89 19.25% 19.75% 19.25% 20.64%
5/7/89 19.50% 20.75% 19.50% 20.75%
8/2/90 18.50% 20.25%
(Fixed rate fixed for 2 years)
(# Calculated from date debt incurred to 8/2/90)
Table 1
32 - HIRE and RENTAL - APRIL 1990
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In the recent past, it can be seen that
fixed rate borrowing had an advantage
over the variable rate loans. Had interest
rates been reducing in this period, rather
than increasing, the variable rate option
would have proved more beneficial to a
borrower, but the amount of that benefit
depends upon the scale and timing of the
downward movement.
The things to be considered in choosing
between fixed or variable interest
rates are -
. the actual difference (margin) between
the two rates;
• the period for which the rate can be
fixed;
. government policy regarding interest
rates;
• expectations regarding the economy,
including offshore influences affecting
the Australian economy;
. whether there is in fact an option to
change back to variable rate once
having chosen a fixed rate; and
. any cost, in the form of an early repayment
fee, for opting out of the fixed
rate.
Even though variable rates may appear
to be preferable while rates
generally are decreasing, that benefit
may not match the savings achieved
while rates are increasing due to the
"margin" between the two rates and the
speed with which rates may reduce.
While the basics have been set out in
this article, it is a subject that is best
discussed in detail with your Accountant
or Financial Advisor to ensure the
advice fits your particular circumstances.
But if you wish to discuss any other
aspect of CDB's Term Loans, you can
telephone us toll free on 008 011164.