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Empower Wealth Blog post by Empower Wealth

SPECIAL – Fixed Rate Mortgage Report


HOW ARE FIXED RATES FUNDED?

Refresher from my comment in our May 2009 newsletter on fixed rates:

Funding Fixed Mortgages – Lenders tend to outsource funding on money markets, via other banks/lenders – swap rates, through government bonds or via fixed savings deposits of similar duration which they collect from their own retail deposits, locking in their spread or profit margin for similar timeframes, as they plan to lend out this money. Bill Evans – Westpac Chief Economist noted in his April 20th comment in Westpac weekly economic report called Australian Weekly “Around 40% of banks’ funding costs are affected by the bank bill rate but the remainder are determined by retail deposit rates (40%) while around 20% of funding costs are independent of market rates (capital; non interest bearing deposits).”

 

HOW HAVE FIXED RATES PERFORMED AGAINST ‘COMPETITIVE’ VARIABLE RATE MORTGAGES?

The table & chart below shows the historical ‘margin’ between a 3 year fixed rate and discount variable rates since it has been tracked by the RBA.

 

Month Cash Rate Discount Var. 3 Yr Fixed Margin b/w Discount Var. & 3 Yr Fixed Rates
Jun-2004

5.25

6.60

6.95

-0.35

Jul-2004

5.25

6.60

6.95

-0.35

Aug-2004

5.25

6.60

6.95

-0.35

Sep-2004

5.25

6.60

6.85

-0.25

Oct-2004

5.25

6.60

6.70

-0.10

Nov-2004

5.25

6.60

6.65

-0.05

Dec-2004

5.25

6.60

6.60

0.00

Jan-2005

5.25

6.60

6.60

0.00

Feb-2005

5.25

6.60

6.75

-0.15

Mar-2005

5.50

6.80

6.90

-0.10

Apr-2005

5.50

6.80

6.90

-0.10

May-2005

5.50

6.80

6.85

-0.05

Jun-2005

5.50

6.80

6.85

-0.05

Jul-2005

5.50

6.70

6.85

-0.15

Aug-2005

5.50

6.70

6.85

-0.15

Sep-2005

5.50

6.70

6.55

0.15

Oct-2005

5.50

6.70

6.55

0.15

Nov-2005

5.50

6.70

6.65

0.05

Dec-2005

5.50

6.70

6.70

0.00

Jan-2006

5.50

6.70

6.70

0.00

Feb-2006

5.50

6.65

6.70

-0.05

Mar-2006

5.50

6.65

6.65

0.00

Apr-2006

5.50

6.70

6.85

-0.15

May-2006

5.75

6.95

7.00

-0.05

Jun-2006

5.75

6.95

7.05

-0.10

Jul-2006

5.75

6.95

7.20

-0.25

Aug-2006

6.00

7.20

7.30

-0.10

Sep-2006

6.00

7.20

7.25

-0.05

Oct-2006

6.00

7.20

7.25

-0.05

Nov-2006

6.25

7.45

7.25

0.20

Dec-2006

6.25

7.45

7.25

0.20

Jan-2007

6.25

7.45

7.30

0.15

Feb-2007

6.25

7.45

7.30

0.15

Mar-2007

6.25

7.45

7.30

0.15

Apr-2007

6.25

7.45

7.45

0.00

May-2007

6.25

7.45

7.45

0.00

Jun-2007

6.25

7.45

7.50

-0.05

Jul-2007

6.25

7.45

7.70

-0.25

Aug-2007

6.50

7.70

7.80

-0.10

Sep-2007

6.50

7.70

7.75

-0.05

Oct-2007

6.50

7.70

7.85

-0.15

Nov-2007

6.75

7.95

8.20

-0.25

Dec-2007

6.75

7.95

8.35

-0.40

Jan-2008

6.75

8.10

8.45

-0.35

Feb-2008

7.00

8.35

8.70

-0.35

Mar-2008

7.25

8.70

8.95

-0.25

Apr-2008

7.25

8.80

8.95

-0.15

May-2008

7.25

8.85

8.95

-0.10

Jun-2008

7.25

8.85

9.30

-0.45

Jul-2008

7.25

8.95

9.40

-0.45

Aug-2008

7.25

8.95

8.90

0.05

Sep-2008

7.00

8.75

8.50

0.25

Oct-2008

6.00

7.70

7.30

0.40

Nov-2008

5.25

7.10

6.90

0.20

Dec-2008

4.25

6.20

6.25

-0.05

Jan-2009

3.25

6.20

5.85

0.35

Feb-2009

3.25

5.20

5.65

-0.45

Mar-2009

3.00

5.20

5.60

-0.40

Apr-2009

3.00

5.10

5.85

-0.65

May-2009

3.00

5.10

6.05

-0.95

Jun-2009

3.00

5.15

6.50

-1.35

Jul-2009

3.00

5.15

6.50

-1.35

Aug-2009

3.00

5.15

7.00

-1.85

Sep-2009

3.00

5.15

7.15

-2.00

Oct – 2009

3.25

5.40

7.60

-2.20

Nov – 2009

3.25

5.65

7.60

-1.95

Dec – 2009

3.75

6.00

7.60

-1.60

Jan – 2010

3.75

6.00

7.70

-1.70

Feb – 2010

3.75

6.00

7.70

-1.70

Mar – 2010

4

6.25

7.75

-1.50

 

The margin appears to have peaked in October 2009 at 2.20

 

The chart below shows how the graph was looking back in Aug 2009.  Comparing the chart above with the chart below shows us that, as I predicted, fixed rate increases would slow down and the margin between the average discounted variable rate and the average 3 Year fixed rate would lessen and will start returning to its longer term margin around the 0.15% to 0.30% variance, i.e. 3 Year fixed rates about 15 basis points higher than the discounted variable rate of the day.

The reason behind the margin moving back to its longer term trend is a result of the swap rates easing and liquidity flowing back into the system, coupled with investors moving cash out of these safe haven investments and back into the stock markets as returns and yields improve in this market, thus lessening the demand in the bond markets which makes these funds cheaper for the banks to buy.

That’s a very simplistic summary, but in short we should continue to see these margins reduce and fixed rates not increasing as rapidly as they have over the past year.  Variable rates should get very close to catching up to them, if competition remains in the market.  So if your lender is increasing rates, call us because there will be good deals to be had and it may not be with the big lenders.

 

WHAT’S OUT IN THE MARKETPLACE CURRENTLY?

Let’s take a look at how all this relates in ‘consumer land’ by viewing a couple of lenders’ historical interest rates

 

 

 

Comparison on $250,000 Interest Only Loan

Lender

Date

Discount Var.

3 Yr Fixed

5 Yr Fixed

Margin b/w Dis. Var. & 3 Yr Fixed

Mthly Int. Savings  Dis. Var. to 3 Yr Fixed

Margin b/w Dis. Var. & 5 Yr Fixed

Mthly Int. Savings Dis. Var. to 5 Yr Fixed

CBA – Pro Pack

04-Jun-09

5.14%

6.04%

6.69%

-0.90%

$ 187.50

-1.55%

$ 322.92

01-Jul-09

5.24%

6.54%

7.19%

-1.30%

$ 270.83

-1.95%

$ 406.25

05-Aug-09

5.24%

6.54%

7.19%

-1.30%

$ 270.83

-1.95%

$ 406.25

06-Oct-09

5.24%

7.14%

7.64%

-1.90%

$ 395.83

-2.40%

$ 500.00

22-Apr-09

6.61%

7.74%

8.04%

-1.13%

$ 235.42

-1.43%

$ 297.92

NAB – Pro Pack

04-Jun-09

5.04%

5.74%

6.39%

-0.70%

$ 145.83

-1.35%

$ 281.25

01-Jul-09

5.04%

6.39%

7.09%

-1.35%

$ 281.25

-2.05%

$ 427.08

05-Aug-09

5.14%

6.39%

7.19%

-1.25%

$ 260.42

-2.05%

$ 427.08

06-Oct-09

5.24%

6.89%

7.59%

-1.65%

$ 343.75

-2.35%

$ 489.58

22-Apr-09

6.29%

7.49%

7.79%

-1.20%

$ 250.00

-1.50%

$ 312.50

WBC – Pro Pack

04-Jun-09

5.11%

5.89%

6.49%

-0.78%

$ 162.50

-1.38%

$ 287.50

01-Jul-09

5.11%

6.39%

6.99%

-1.28%

$ 266.67

-1.88%

$ 391.67

05-Aug-09

5.11%

6.99%

7.59%

-1.88%

$ 391.67

-2.48%

$ 516.67

06-Oct-09

5.11%

6.99%

7.64%

-1.88%

$ 391.67

-2.53%

$ 527.08

22-Apr-09

6.56%

7.59%

7.94%

-1.03%

$ 214.58

-1.38%

$ 287.50

ANZ – Pro Pack

04-Jun-09

5.21%

6.34%

7.19%

-1.13%

$ 235.42

-1.98%

$ 412.50

01-Jul-09

5.21%

6.34%

7.19%

-1.13%

$ 235.42

-1.98%

$ 412.50

05-Aug-09

5.21%

6.34%

7.19%

-1.13%

$ 235.42

-1.98%

$ 412.50

06-Oct-09

5.21%

6.99%

7.74%

-1.78%

$ 370.83

-2.53%

$ 527.08

22-Apr-09

6.46%

7.83%

8.18%

-1.37%

$ 285.42

-1.72%

$ 358.33

St G – Pro Pack

04-Jun-09

5.09%

5.99%

6.64%

-0.90%

$ 187.50

-1.55%

$ 322.92

01-Jul-09

5.09%

6.49%

7.14%

-1.40%

$ 291.67

-2.05%

$ 427.08

05-Aug-09

5.09%

6.94%

7.59%

-1.85%

$ 385.42

-2.50%

$ 520.83

06-Oct-09

5.09%

7.09%

7.64%

-2.00%

$ 416.67

-2.55%

$ 531.25

22-Apr-09

6.48%

7.54%

7.94%

-1.06%

$ 220.83

-1.46%

$ 304.17

ING

04-Jun-09

5.09%

5.89%

6.69%

-0.80%

$ 166.67

-1.60%

$ 333.33

01-Jul-09

5.09%

6.69%

7.39%

-1.60%

$ 333.33

-2.30%

$ 479.17

05-Aug-09

5.09%

6.89%

7.39%

-1.80%

$ 375.00

-2.30%

$ 479.17

06-Oct-09

5.09%

7.09%

7.49%

-2.00%

$ 416.67

-2.40%

$ 500.00

22-Apr-09

6.79%

7.59%

7.94%

-0.80%

$ 166.67

-1.15%

$ 239.58

Note: The interest rates shown in this table are based on advertised rates – no comparison rates are shown and therefore no decision on taking out a loan should be based on these interest rates, as other costs, such as fees and charges will impact on the overall cost of the loan – this illustration is purely to show the dollar variance between the interest rates on a $250,000 interest only loan, between the two different interest rates.

 

Observation:  The above comparison clearly demonstrates that although the fixed rate is slowing in terms of its increase compared to the recent increase in variable rates, the discounted variable rates are still offering considerable monthly savings over the current fixed rate pricing.  However these variances are decreasing as you can see from their peaks around October last year when the margins were at their greatest.

Currently the best 3 year fixed rate we have on our 25+ lender panel, is offering a fixed rate of 7.39%

 

 

WILL THE CASH RATE SLOW AND IF SO, WHAT DOES THAT MEAN TO VARIABLE RATES?

 

The RBA has pretty much perfected the use of the cash rate to control the economic growth GDP in the economy, which also assists in managing inflation.  The cash rate which affects the interest we pay on our mortgages is used as a powerful lever or instrument in technical terms to control the flow of cash in the economy.  When the GFC hit the RBA moved quickly to reduce the cash rate which then reduced the cost of money, via lower interest we paid on our borrowed money.  Cheaper access to money means more spending and increases our economic activity, the more we spend the more workers we need to make more goods or provide more services.

Yet when the economy is growing too quickly and demand exceeds supply of these goods and services, inflationary pressure hit us, which basically results in each dollar we have not going as far as it used to.  I.e. you can buy less with what you have.

So the RBA tries to manage the level of growth to ensure the economy can stay prosperous for as long as possible, by using cash rate to control the money that’s available in the economy.

When interest rates went down recently, it meant that those of us who have a mortgage or any debt (the vast majority of households) then the impact is our money goes further and we have the ability to pay our debt down quicker or we can use this surplus cash and go and spend it on ourselves through what is deemed discretionary or ‘lifestyle’ spending.  The latter is what most of us did, we went out and spent that surplus money and the economy started to respond and we avoided a recession.

Now the economy is moving ahead around what the RBA believes to be acceptable trend level of 2-3% GDP.  Here’s what the Reserve Bank assistant governor Guy Debelle told a Senate committee on 20th April, when asked about the economy and interest rates:

“We’re moving back to something around about average levels (grow), which is not far away from where we are at the moment, given our expectations on where the economy is going,” he said.

(Interest Rates) “Our assessment is they are about where the average of where they have been since 1997. They are coming off obviously very low levels, as low as they’ve basically been for the past thirty or forty years, and they’ve risen back to about where they’ve been for the last 10 or 15 years.”

The past 5 rate rises have removed a lot of discretionary money out of the household budget and many families are now tightening their belts once again.  Evidence of this is occurring in the recent consumer spending figures within the retail sector.  If this keeps going then retail jobs and the people who manufacture the goods we buy will be affected, and eventually the economy in this area will slow.  How that impacts on the greater economy is the more serious question. I.e., if the mining boom continues then rates may continue to climb a bit higher – say 9%, however I tend to believe we as a country are too debt laden and once the interest we are paying hits around the 8-8.5% level, our economy will slow to a point whereby interest rates will stagnate or hopefully return to their long term average of around the 7.25% mark.  (This average level is calculated by a measure of interest rates since the RBA was made independent of Government influence).

 

MY OBSERVATIONS

I suppose I’m arguing that something will have to give, given the debt levels held by vast numbers of the population, yet our overall sentiment currently is for economic growth and improved outlooks into the second half of 2010 and into 2011 and beyond, therefore it’s my view the cash rate will slow and hopefully level out once again around our long term levels.

Interest rate talk of 10% in late 2011 and 2012 for us to be paying in my eyes will not materialise, as the majority of households will not be able to afford these sorts of levels.  For the record, if they do materialise, expect property prices in the outer suburbs or mortgage belts to drop and they may drop by double digits!  It should also put the brakes on a property market that is growing at an unsustainable pace, which is not a bad thing for the long term benefit of this market.  Also expect rents in the high demand area to increase in double digit terms, given the shortage of accommodation and the higher interest costs landlords will pass onto their tenants.

 

SO WHY WOULD YOU FIX? – MY MESSAGE REMAINS THE SAME

Fixing your interest rate for a period of time is an insurance policy of rates going beyond what your household can afford.  It’s about buying peace of mind.  It is a bet, on one side, rates could go down and you are simply loading the coffers of the shareholders of the banks through increased profits, but on the other hand it could mean you tip over the edge and cannot afford to hold your home or investment, which could set you back decades!

My Tip – Those whose household budgets will struggle with rates higher than 8% will need to take action. Contact our office and speak to one of our mortgage specialists.  They have their finger on the pulse and know what great offers are out in the market place every day.  Furthermore, for new comers to us, this service is a free service.

Having this knowledge will empower you to make a more informed decision, if you are better to fix or stay variable.

 

Commentary & Opinion of Ben Kingsley – CEO & Founder; Property Investment Analyst and Advisor

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