The impact of high inflation on how long you should fix for.

[BigBoots82]

Copied from another thread where someone asked if they should fix for 7 years at 1.95% or 20 years at 2.5% - Brendan


The value of money may be significantly lower in 7 years time also due to inflation. I'd be fixing for 7 years.

 

[Brendan Burgess]

Assuming a balance of 100k, you will pay €11,800 interest over the next 7 years if you stay as you are.

If you fix for 20 years at 2.5%, you will pay €15,300 - so an extra €3,500 in interest

 

[Brendan Burgess]

So you will save €500 at 2022 prices. €500 at 2023 prices etc.

Even if you end up paying more interest after year 7 because interest rates are then above 2.5%, you will be paying that extra interest at 2028 prices which will be a lot less in real terms than 2022 prices.

I had not thought of this issue before. It suggests avoiding very long term fixed rates.

Brendan

 

[Brendan Burgess]

If we do have very high inflation, interest rates will rise to combat it.

That will take some time to work. So fixing for two years would be wrong as you would be coming off the fixed rate into an era of very high rates.

If you fix for 5 years or 7 years, inflation should have been sorted by then, and interest rates will probably be at a reasonable level.

Brendan

 

[Sir Bob Paisley]

That is interesting Brendan. I have 237,000 left and was looking to fix for 15 years with Avant at 2.4% and possible clear the mortgage in 13 with 10% overpayments.
House valued at €1025000.
So I shound be looking at 7 years fixed at 1.95%?

 

[Brendan Burgess]

This is what I am trying to figure out myself.

You will save .45% of €237k in 2022 money which is €1,000

After 7 years, if the rate is above 2.4% which it probably will be, you will pay extra.

But your balance will be down to €172k.
Let's say that the best mortgage rate then is 3.4%
You will pay €1,700 extra in 2029. But that will be €1,700 2029 euros which would be the equivalent of, say, €1,200 2022 euro.

You will owe less than €172k if you make overpayments of 10% a year.
And you want to make overpayments in excess of 10%, the early break fee should be less for a 7 year mortgage than a 15 year mortgage.

Brendan

 

[Duke of Marmalade]

Let us for sake of argument say the saving is €1k p.a. for 7 years and let's say on average (it will be naturally reducing) €2k savings per annum for the next 8 years.
That is a cash-flow schedule of 7 negatives (comparing the long with the short option) followed by 8 positives.
To evaluate this in real terms (i.e. inflation adjusted) you put the schedule up on a spreadsheet and discount it at the rate of inflation. Clearly with inflation of 0% we get €9k (€16k - €7k) in favour of the long option. A constant rate of inflation of 12% would make the cash-flow schedule neutral (=0). Higher than this would tilt the balance in favour of the short option.
A burst of inflation followed by lower steady inflation would be more towards the short option than a constant rate of inflation.

 

[Brendan Burgess]

Duke

That is a great explanation. Thanks.

So any inflation tends to make the shorter fixed period more attractive.
The higher the inflation, the more attractive the shorter period.
The sooner the inflation hits, the more attractive the shorter period.

It won't probably concern us for a while, but if we end up with a period of deflation, the opposite would be the case.

Brendan

 

[Duke of Marmalade]

Duke

That is a great explanation. Thanks.

So any inflation tends to make the shorter fixed period more attractive.
The higher the inflation, the more attractive the shorter period.
The sooner the inflation hits, the more attractive the shorter period.

It won't probably concern us for a while, but if we end up with a period of deflation, the opposite would be the case.

Brendan

That is true in terms of the discount rate but it goes the opposite way in terms of where you think interest rates are going. The higher the inflation rate the more likely the rise in interest rates.
It is a balancing decision. Of course the easy way out is to say the financial markets have the the thing sussed and there is no such thing as one interest rate option being better than another.
I think most people chose fixed not on its actuarial metrics but for some sense of security. The fear of 80s style mortgage rates makes fixing for as long as possible the preferred option even if not quite "actuarially" correct.