Where to with regard home loan interest rates?

Recent interest rate cuts to 'historic lows' in Australia, combined with high property prices (especially in Sydney and Melbourne) have lead to a lot of speculation about how low interest rates will drop (after yesterday's 0.25% cut I've seen some pundits predict a further two cuts by the middle of next year), and when/if rates will increase again -- and by how much.

This is an especially hot topic amongst comments regarding property prices and loan affordability. Many comments are along the lines of 'prices are too high, and will drop 40% or more' -- which reminds me a lot of Dr Keen's prediction about a '40% fall in property prices) back in 2008. Many of the comments also assume that the current low interest rates are an aberration, and that home loan mortgages *must* rise substantially -- which will lead to mortgage stress and potentially a significant rise in mortgage defaults.

While home loan interest rates are certainly very low and can't fall much further (given that RBA cuts below 0% would be ineffective, so the focus would shift to QE instead. and that banks set home loan rates which also reflect non-zero deposit rates and their admin/overhead costs), this doesn't mean that home loan interest rates must rebound. After all,taking a really long view, current home loan interest rates are back down to what was considered 'normal' prior to WWII.

I've cobbled together a couple of historic charts of Australian average 30-year home loan interest rates below, and extended it to include recent rate changes. This chart shows that the current home loan interest rates might actually be 'normal' for an economy with low growth rates and inflation, and little prospect of major rises in productivity (unless AI turns out to have as big an impact as computerisation and robotics had in the 1970s-2000s).

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Earn a bonus $75 on your savings at RateSetter

I started using RateSetter back in March, and I've been saving $100 (automatically transferred from one of my bank accounts) every month and investing it at around 9%pa using the 5-year lending option. While such peer-to-peer lending is obviously much more risky than investing your money in a bank savings account, the higher interest rate is (hopefully) commensurate with higher risk. Also, if you invest in 5-year lending, only some* of your investment will be locked up for the full five years.

At the moment, RateSetter is offering a $75 bonus^ if you join RateSetter using this referral link and invest $2000 or more in the 3-year Income or 5-year Income lending market before 16 September 2018. So, if you were thinking about saving some funds in a RateSetter lending account, get in quick for the chance of a bonus $75!

Last Matched Rates on RateSetter:
1 MONTH 5.0% at 14:36
1 YEAR 4.0% at 14:31
3 YEAR INCOME 7.4% at 13:19
5 YEAR INCOME 9.0% at 15:06
GREEN LOAN 6.5% at 14:25

* Investing in 5-year loans, you get a monthly repayment of interest and capital into your holding account (which I reinvest each month), so the initial investment isn't locked away for the entire loan period.

^ You will get a $75 bonus and so will I. Full disclosure ;)

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Fixed the interest rate on part of our home loan

Most (90% or so) of home loans in Australia are variable rate, and fixed rate loans are generally only available for terms up to 5 or 7 years. My parents had a 30-year fixed rate home loan when they bought a house back in the early 1960s, but Australian banks moved to the 'standard' variable rate loan during the high inflation (nearly 20%) period of the 1980s.

We fixed the interest rate on our investment property loan for five years when rates started to climb about four years ago. And we will probably end up paying about the same average interest over the five year period as if we had stuck with a variable rate (due to the recent record low interest rates).

We had been hoping to change part of our home loan from variable rate to a fixed rate this year, and I had expected the fixed rates on offer to keep dropping during 2009 as the RBA keeps cutting the official interest rate. However, the last rate cut by the RBA didn't result in much change in the variable rates of the 'big four' Australian banks, and yesterday the Commonwealth and Westpac banks announced a RISE in their fixed rate loan interest rates. So today we took advantage of my day off to do the paperwork for moving $270,000 of our home loan to a fixed rate of 5.34% for three years. There is a $500 fee involved, so over three years the effective fixed rate will be around 5.5%. This is higher than the current standard variable rate (with a 0.7% negotiated discount), but may save us some money over the next three years if the economy starts to recover towards the end of 2010 and interest rates start to trend up again.

We still have the other $230,000 of our home loan at the negotiated variable rate, so we're hedging our bets.

Subscribe to Enough Wealth. Copyright 2006-2008

Cut! Cut! Cut!

I think everybody (except those on the board of the Reserve Bank) were surprised when the RBA announced a massive 1.0% cut in the official interest rate. Nearly everyone in the media had been predicting that the RBA would follow up last month's 0.25% cut with another cut, but they were expecting the RBA would perhaps double their usual adjustment by making a 0.5% cut. The decision to cut by a massive 1.0% suggests a couple of things:
1. That the RBA, having only stopped INCREASING rates with last month's cut, was scrambling to "get ahead of the curve" now that the world economy looked like going pear-shaped in a hurry
2. That with the recent plunge in oil and commodity prices they are no longer worried about the inflation rate staying above the target 2%-3% band for long. There had always been a few that the RBA shouldn't have been too concerned about the part of the inflation surge that was purely extrinsic (caused by commodity and oil price spikes) as it was a one-off (like the introduction of the GST). Now it looks as if at least part of that inflation component will be unwound as commodity prices drop back to sustainable levels.
3. That they have started to worry about just how robust the Australian economy can be when the EU and USA are falling into recession. The view that the Australian economy would continue to grow due to the expansion of the Chinese economy assumes that the Chinese economy will continue to grow strongly even if the EU and USA are in a prolonged recession, due to domestic demand. However, domestic Chinese demand will surely slow as exports drop off and inventory starts to accumulate.

The big banks appear to be passing on around 0.75% of the interest cut, which will benefit our cash flow. We have around half of our property loans at a fixed rate for a few more years, but the half that is at variable rate will benefit from the rate cut. 0.75% interest rate cut will trim our interest payments by around $230 each month.

Subscribe to Enough Wealth. Copyright 2006-2008

Margin lending dilemma

The end of the financial year is nigh, so it's once again time to decide whether or not to pre-pay the next twelve months interest. The main benefit of doing so is that if it's paid before 30 June the entire amount is deductible in this year's tax return. The other potential benefit of pre-paying the interest is that the interest rate is fixed, rather than being variable if you are paying monthly. There appears to be little chance of an interest rate cut in the next twelve months, but some possibility that the interest rate might increase another 0.25% or 0.50%.

Each of my three margin lenders is offering different interest rates for prepaying twelve months interest. St George margin lending is offering 10.25%, but because we have our home and residential investment property loans with them we are "gold" clients, so I get a 0.25% discount on the interest rate, bringing it down to 10.00%. Yesterday I faxed in the paperwork to fix and prepay the interest on $70,000, which is almost the entire loan balance on this account.

I'll probably also fix and prepay most of the loan balance on my leveraged equities account, but I'll leave about $8,000 at the variable rate so I can reduce the loan balance at any time if I sell off some odd stock lots that were left sitting in this account after some takeover activity. Leveraged Equities usually mails me a prepayment form in early June, so I don't yet know what interest rate is on offer. Hopefully it will also be 10% or less.

My third Australian stock account on margin is with Commonwealth Securities (ComSec). They sent out a prepayment offer last week, but the interest rate on offer is an exorbitant 10.35%! This account has my largest margin loan balance (just over $150,000), so I'll have to phone them and try to negotiate a better rate. If they won't come to the party I'll consider transferring the holdings to my St George margin loan account. I'd rather not have to do so, as it might trigger a capital gains tax liability. It might also be a hassle arranging for the Comsec loan to be paid out if the shares on that account are transferred to my St George margin account.

The higher interest rate charged by ComSec seems even more excessive considering that they don't pay any trailing fees to brokers (as I found out from YourShare when I arranged to get a 50% rebate of trails on my various investment and loan accounts by making them my nominated broker). If I borrow funds from St George rather than ComSec I would get a rebate of trailing fees worth around 0.15% in addition to the interest rate being 10.00% rather than 10.35%

The interest rates on my margin loans have increased from around 8% a year ago, to around 10% today. There's considerable risk that the overall ROI of my stock investments won't exceed 10%pa in the medium term, which would make the use of gearing an ineffective investment strategy. However, most of my Australian stock holdings include considerable unrealised capital gains, so I'm not keen on selling stocks in order to reduce my margin loan balances at this time.

If interest rates drop and margin lending remains a useful investment strategy, I'm hoping to be able to liquidate these holdings gradually during my retirement. Under the current superannuation rules my SMSF pension income won't be taxable and doesn't even have to be included on tax returns. This would (I think) mean that it wouldn't be counted as income when working out the marginal tax rate to be applied to any capital gains realised during retirement. On the other hand, the Rudd government has indicated that they want to include such retirement pension income in some social security calculations, so presumably the data would then be available to the ATO and might end up also affecting capital gains tax calculations.

It's a bit hard trying to make sensible decisions about taxation planning when the rules can change at any time. In fact, some Labor politicians have expressed a desire to do away with the current 50% CGT concession for "long term" capital gains, so holding on to my stocks could end up costing me a lot extra tax in the long run. Perhaps I should hedge my bets by selling off a portion of my Australian stock portfolio and use the proceeds to reduce my margin loan balances. Of course, if I want to do that during the next financial year I can't fix and prepay the entire loan balance. Decisions, decisions...

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Better never than late

The problem with changing from a variable rate home loan to a fixed rate loan is that by the time it seems like a good idea, the horse has probably already bolted. Locking in a fixed rate at the top end of the interest rate cycle is worse than doing nothing.

We converted around half of our home mortgage balance (home and investment rental property) into a five-year fixed rate loan a little under two years ago. At that time rates in Australia had already bottomed out and there had been a couple of 0.25% increases in the variable interest rate. But fixed rates were still lower than variable as a lot of commentators were expecting rates to top out and start dropping again fairly soon. Most home loans in Australia are taken as variable rate loans (similar to US ARMs), and at that time not many homeowners were choosing to move to fixed rate loans.

Two years later and our fixed rate loan is looking pretty sweet after a string of four 0.25% rate rises by the reserve bank in the past year, plus an extra 0.2%-0.3% increase in home loan rates added by the Australian banks due to the increased cost of funds caused by the global credit crunch. Recent figures show that fixed rate mortgages are becoming more and more popular, as home owners get concerned about the prospect of further rate rises.

But is this a good time to be choosing a fixed rate loan? While a fixed rate eliminates the risk of increased loan payments in the future, it also locks in the rate rises of the past two years. If variable home loan rates drop substantially in a year or two, getting out of a five-year fixed rate loan would be very expensive. Although no-one has a particularly good track record at predicting future interest rate movements, the fact that longer term fixed rate loans are available for lower rates than the current variable rate loans suggests that future rate movements are more likely to be down than up.

For example, for a home loan St George bank is currently advertising:

Variable rate....9.37%
1-year fixed.....9.05%
3-year fixed.....8.95%
5-year fixed.....8.90%

and similarly, a margin loan rates from a couple of lenders are:

1-year fixed.....9.8%
2-year fixed.....9.7%
3-year fixed.....9.6%

For the three and five year fixed rates to be 0.2% lower than the current standard variable rate (when most pundits think there's a good chance of one more 0.25% rate rise by the RBA in the next few months) suggests that the banks and other lenders expect interest rates to have dropped by around 0.5% over the next couple of years.

I won't be rushing out to fix the variable rate part of our home loans at this time, but it may be a good time to rollover our current fixed rate loan when it matures in another three years.

Copyright Enough Wealth 2007

US Sub-prime woes hurt Australian Home Buyers

For months the Australian banks have been bemoaning the impact that the global credit squeeze has had on their home loan margins. With borrowers already under pressure from high house prices and the rates increases made by the Reserve Bank of Australia to contain inflation, none of the big four banks were willing to be first to increase their lending rates for fear of losing market share. But today two of the banks finally decided to increase their lending rates independent of any move by the RBA - National Australia Bank increasing it's standard variable loan by 0.12% to 8.69%, and ANZ Bank increasing it's fixed rate loan rate by 0.25% to 8.54%. The one positive of this move may be that the RBA feels less urgency to increase the official rate by another 0.25% when they next meet, as the banks will have done some of the work for them.

Copyright Enough Wealth 2007

Rate Increase Hits Hip Pocket

The Reserve Bank of Australia raised the official cash rate by 0.25 percentage points to 6.75 per cent this morning, for the first time ever during a federal election campaign.

Personally, this won't have a huge impact on my hip pocket. My half of our property mortgages is currently $363,152 but around 1/3 ($118,949) is at on a fixed rate for the next several years. The interest rate charged on the remaining $244,203 variable rate loan will probably go up by the full 0.25% almost immediately. This will result in my paying extra $50.88 per month in interest.

It is widely predicted that the rate rise will dampen demand for loans by first home buyers and prolong the slump in new home construction. This should be good for us in the medium term as there is already considerable undersupply of housing (due to high rates of immigration and a recent up tick in the birth rate) which will help lift rentral yields above the current rate of around 10% increase pa and reduce vacancy rates even further. This should allow us to recoup most of this cost increase when do our annual rent review early next year.

Copyright Enough Wealth 2007