On May 5th 2015, the Reserve Bank of Australia cut the official cash rate by 0.25%. The cash rate is now at a historic low of 2.00%. This has been the second rate cut in 2015, the first was in February. The cash rate has now fallen 0.50% since new years day.
To the average Australian with a mortgage of $350,000, a cut of 0.50% equates to savings of $145.83 per month in interest. 2015 has been a happy year so far for borrowers. People with savings are not enjoying the year quite as much. They have seen the interest income they earn fall to below inflation rates, so in real terms, savings are losing value.
How much better off is the average Australian home borrower? That depends on how you react to the rate drop. If you reduce your repayments, you now have an extra $145 to spend each month , if you keep your repayments unchanged, then the benefits are shown below:
If you took out a $350,000 30 year variable home loan in January, your repayments would've been around $1,948 per month. If you kept your repayments at $1,948 per month, you would pay off the loan in 26.7 years, and would save a little over $77,000 in total repayments.
Australian mortgages have a reputation for favouring variable rates. In 2014, fixed loans only represented 13.7% of the total Australian mortgage market. With rates at an all time low, we'd think that a lot of borrowers will be asking 'is now a good time switch to a fixed rate home loan?' We thought we'd help you make this decision with a Finance Guy streetonomic look at interest rates and mortgages.
Whether or not now is the right time to lock in your home loan will depend on your personal circumstances. To help you make this decision, we will discuss aspects which think are common to all borrowers. These include:
- What fixed rates and variable rates are available
- Your expectation of where rates will go in the future
- How will fixing change the way you use your mortgage
- Our Streetonomic view
What Fixed and Variable Rates are Available to You?
For simplicity, we looked at rates available on a $350,000 home loan. We only looked at the Australian Big Four Banks, we looked at the advertised discount rates offered under their respective discount packages. Our findings are shown in the table below:
We are seeing some rare anomalies in this table, which may influence your decision over whether or not to fix your home loan. In our experience it is unusual to see:
- The variable rates on offer are higher than the fixed rates, with the exception of Westpac, who are running a temporary special deal.
- All four banks are offering a lower rate for 5 year fixed than 3 year fixed.
- For CBA and Westpac, the 5 year fixed rate is lower than the 1 year fixed rate, ANZ and NAB are running 1 year specials
What does this table tell us?
Seeing a 5 year fixed rate which is lower than the discount variable rate, is very rare. Seeing a 5 year fixed rate lower than a 1 year fixed rate is extremely rare. The banks are pricing home loans to make the 5 year fixed rate the most attractive option. Does this make it the best option for you, or the most profitable option for them? As with all products, we assume that with loans, profitability is a priority in the pricing process. Banks want you to lock in your mortgage for 5 years because it's best for them (and might be best for you too).
Why Do Banks Want Us to Fix for 5 Years?
It locks us in - Compared to variable, fixed rate mortgages are difficult to refinance. When you agree to 'lock it in'. The bank can't change the interest rate, but if you try and close your loan (because of refinancing or sale of the property), you will incur a 'break cost'. This fee can be quite substantial and may even prevent you from exiting your fixed loan. The break cost is calculated based on how much time was left on your fixed loan, and the difference between the fixed rate you are on and the prevailing variable rate. Fixed rates are the mortgage equivalent of golden handcuffs 'we are locked into this attractive agreement and breaking it in the future will have consequences'
While we believe the banks are pricing fixed and variable loans so as to maximise their profits, we could be wrong! It is possible (yet, in our view, improbable), that due to the drop in interest rates, Australian mortgagors have suddenly started asking for fixed rates, and they want a 5 year rate! This shift in consumer sentiment may have caused the banks to recognise that the most sought after mortgage in Australia, is the 5 year fixed rate, and now they are all fighting for a share of the current 'hot market'. The views of The Finance Guy are influenced by his work (which includes dealing with clients in a mortgage broking capacity), and other stuff too.
The Big Four represent 84% of the Australian mortgage market. It would appear that only 16% Australians have discovered that better rates can be found, but it takes more extensive research. Want to find the best rate you can get? Just send us Just send us an e-mail and we'll arrange for a mortgage broker to give you an obligation free consultation
Your Expectation of Where Rates are Headed
You want to fix your home loan because it's a good deal right? It's a good deal in your opinion, but how do the banks view it? This is unsubstantiated speculation, but we believe that banks price mortgage rates based on their economic forecasts of where interest rates are headed. To us, 4.59% is an attractive rate in 2015. How sure are you that it will be an attractive rate for the next 5 years?
Banks are pricing home loans in line with their expectation that rates will continue to fall, or remain stable over the next 5 years. Banks are not expecting rates to go up. If you lock in today, you are betting against their opinion. You are saying 'today's rate is great and will be great for 5 years'.
Nobody can predict the future, the only thing we know for sure is that in 5 years time, hindsight will well and truly be '2020'. Banks don't have a flying Delorean or The Oracle form The Matrix, but they do have more resources than us. They have expensive mathematics software, and overpaid economists to help them predict the future of interest rates.
With the inability to know what is in store for the Australian economy, The Finance Guy does not anticipate the RBA cash rate moving upward in the near term future. We don't have access all the data, but we have read the most RBA Monetary Policy Statement, and RBA minutes of the board meeting, (even though the minutes felt like hours, no make that weeks).
Banks believe that Australian interest rates are on a downward trend, we agree! We read through 5 pages of RBA data to arrive at this opinion, and here are the highlights:
- Australian Economic Growth is below average - so we need more economic stimuli, how about another rate cut?
- Unemployment Rate likely to remain 'elevated' - Need to fight unemployment? Let's drop interest rates!
- Inflation was lower than forecast - The books we read at university told us that dropping interest rates could cause prices to increase. This is not happening, therefore the economy is safe for further interest rate drops!
- Global Growth is low - The whole world is dropping rates because of the economic times, we're not wrong by joining in are we?
- China is slowing - our major export partner, if they don't buy our coal, copper and other mining stuff, who will?
- Growth with trading partners eased - China isn't the only customer buying less of our exports. It's almost as if the down turn in commodities is somehow correlated to the Australian economy!
- Term of trade are expected to decline - money coming into Australian will decline relative to money going out. Wait, didn't we already say that with the China thing?
How Will Fixing Change Your Mortgage?
Getting a guaranteed rate is awesome, why ride the variable rate roller coaster when you can lock it in? Yet 86.3% of Aussies have variable rate home loans. So what's the problem with our fixed rates? In Australia, there are some important differences between variable and fixed rate mortgages, here is our list:
Portability of the Mortgage - What if there is a better deal? If you have a variable loan, the costs of moving are usually less than $500, and can be zero (if your new bank covers the costs). Getting out of a fixed loan isn't so simple, you will incur break fees? Are you willing to pay that fee if you find a better deal? What if you need to sell your property, will this fee impede the financial feasibility of selling?
Flexibility - Do you want to make unrestricted additional repayments to your mortgage? Do you want convenient, no fee, online access to your redraw? These features are unlimited with most variable loans, but not with fixed loans. Fixed rate mortgages have limitations when it comes to extra payments and redraws.
Mortgage Offset Accounts - If you are an investor, then y.ou should look into the benefits of a mortgage offset account. 100% offset accounts are available on most variable rate home loans. The same can not be said for fixed rate loans. Most fixed loans either offer a partial offset, or no offset at all. We have seen some with a 100% offset, but they are accompanied by elevated interest rates. Fixed rate mortgages do not work well with offset accounts!
Our Streetonomic View
Australian mortgage rates are currently at a historic low. The RBA rate might fall further, it might not. We can't predict the future, you can, please contact us! Locking in has never looked better, yet neither has variable. It's a tough decision!
Our quickfire advice to borrowers considering fixed is:
- A fixed loan is fixed - If you fix your mortgage, you are locking in with this bank for the duration of the fixed loan. If you close the loan early due to property sale or moving to a new bank, you will pay fees
- Is there more to your mortgage than the rate - Fixing provides certainty, to you and the bank. You know the rates won't change, the bank knows you won't leave them. If you need features such as redraw, offsets or unrestricted repayments, fixed rate loans may not be right for you
There is a Middle Ground - If you are considering fixing, but are unsure about it, then maybe consider a split loan. You do not need to fix your entire mortage! Banks will let you choose a combination between fixed an variable rates. You can have your desired balance between variable flexibility and fixed certainty. If you choose to do this, then you are stuck with your bank for the duration of the fixed rate.
Finding the right bank to suit your personal circumstances is important. This is something The Finance Guy can help with at no cost to you!. Just send us an email, or leave a comment below