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Ben Kingsley Blog post by Ben Kingsley

To Fix or Not to Fix – ‘The question on everyone’s mind…..’

Depending on long term funding costs and increased demand for fixed loans, fixed mortgages can actually go up when the cash rate / variable mortgages are going down, as we have seen just recently. Fixed interest rates don’t automatically move in the same fashion as variable mortgage rates do.

So in my attempt to make an informed comment on this question we need to understand two influencing factors about fixed rates, and their role in affecting the pricing of fixed rates.

  1. Sales demand for fixed rates
  2. How lenders attempt to fund fixed rate mortgages

 

Sales Demand

First thing to remember – most lenders and especially ‘the banks’ are all about making profits, and their role is to sell as many mortgages as they can to help increase their profits.

The banks are anticipating a future ground swell of clients looking to lock in fixed rates, as we reach record low variable interest rates.  So if the banks are now showing early signs of increased demand for clients looking to switch to fixed mortgage, as consumers heed the call of the mass media ‘its time to fix’, then its logical to think that banks will see this as a opportune time to increase their fixed rate and profit from the experience.

 

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 Evan’s – 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).”

Given its near impossible to find out what percentage of funding comes from where, I’d be happy as to have a guess that fixed rates are more reliant on bonds and bank bill rates and longer fixed term deposit funding, than cash rates and short term “at call” retail deposits.  If I am right, then why when I look at the following forecast graph from the same report, are fixed rates actually going up, when long term funding costs are forecast to come down, further?

Westpac’s Economic & financial forecasts – as at week beginning 20th April

 

Interest rate forecasts

Latest                                                     (Apr 17) Jun 09    Sep 09    Dec 09    Mar 10   Jun 10

Cash                                                        3.00        3.00        2.50        2.00        2.00        2.00

90 Day Bill                                             3.06        2.85        2.40        2.30        2.30        2.30

3 Year Swap                                          4.04        4.00        3.80        3.45        3.70        3.95

10 Year Bond                                        4.52        4.10        3.65        3.95        4.20        4.40

10 Year Spread to US (bps)                168         160         140         120         120         120

International

Fed Funds                                              0.25        0.25        0.25        0.25        0.25        0.25

US 10 Year Bond                                  2.84        2.50        2.25        2.75        3.00        3.20
ECB Repo Rate                                      1.25        1.00        0.75        0.75        0.75        0.75

 

Hmmm………maybe there is enough demand out there for the bank to charge what they are charging now?

Here is a table showing the Principal and Interest repayments for a $300,000 mortgage over 25 years based on the average 3, 5 and 10 year fixed rates of the big 4 banks, compared to the average interest rates they are charging for their ‘professional package’ products

Product

%

P&I Repayments p/m

Avg. Variable ‘Pro Pack’ Rate

5.125%

$1775.69

Avg. 3 Year Fixed Rate

5.75%

$1887.68

Avg. 5 Year Fixed

6.48%

$2021.87

Avg. 10 Year Fixed

7.465%

$2210.15

Rates shown are the average retail interest rates of CBA, ANZ, Westpac and NAB

It is very clear from the table above that you would want to be very confident based on this pricing shown, that interest rates are going to move higher and very quickly before locking in.  And that would most likely have to reflect a very quick worldwide economic recovery and /or as we move out of this recessionary phase inflation would have to still be above 4-5% which may force the Reserve Bank’s hand to lift variable rates quickly and aggressively, back to longer term averages.

My thought is this – you need to look at your very own circumstance, as they affect you and no-one else.  What for some might appear the wrong time to fix, might be the best time to fix for others.

For example – Fixing rates for long term investors, could be a really smart idea, as it locks in surety and peace of mind, plus surplus investment funds may then be able to be use to build further wealth or the same could be said for those looking to start a family, the same surety for budgeting purpose could make life a lot less stressful when a new baby arrives. The mass debate and media commentary will continue and only time will be the judge of whether now was in fact the optimum time to fix or not, so it best you focus on wants most important for your financial circumstances by getting some specific advice about your options and that that of a mass commentator, who needs to fill a space in the finance pages of his or her paper.

The one thing I am advocating you do is to get in contact with us, so we can inform you of your own options going forward.  We have hundreds of fixed and variable rate options, so you can make your own informed decision based on your situation and requirements on what’s best for you.

Knowledge is empowering…..

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