It’s the question on the lips of every mortgagee: with interest rates seemingly on the rise, is it time to fix my mortgage rate?
After Commonwealth Bank lifted its variable rate last week and a flurry of banks lifted their fixed rates this week, nervous borrowers are starting to worry whether the historically low rates Australians are currently enjoying can last.
To find out whether the time is right to fix, we asked a range of experts for their views on the trajectory of rates and the outlook for the property sector.
The recent rate increases from the banks would suggest that rates are set to rise. Bond markets are also factoring in rate rises in early 2010, despite the gloomy predictions for unemployment and economic growth.
But these signs may be slightly misleading.
The banks are being forced to increase rates to protect their margins. They are constantly rolling over (or re-borrowing) money to lend to consumers and businesses and while their funding costs have dropped in recent months, the banks are re-borrowing money at much higher rates than 12 months ago.
Economists such as Bill Evans believe bond traders have got a bit overexcited about the so-called ‘green shoots’ of economic recovery.
Shane Oliver, chief economist at AMP Capital Investors, agrees and says that rates will come down as unemployment starts to rise over the coming 12 months. “I still think that the bias is downwards for the cash rate. It’s very unusual for the RBA to raise rates while unemployment is still rising.”
Economists differ on the timing and size of further rate cuts. Certainly the minutes from the Reserve Bank’s latest board meeting indicate it is prepared to take a wait-and-see approach while signs of economic recovery are emerging.
“There is very little chance that the Bank will cut rates again over the next few months, but it clearly stands ready to move should unforeseen developments emerge,” Evans says.
“The main area of uncertainty here relates to the labour market. Presumably the Bank was in broad agreement with the Government’s forecast that the unemployment rate will be rising to 8.5% over the next 12 months. That is nearly three percentage points above current levels and the trauma of such a move, if it is occurring at the same time that the stimulus packages are wearing off, and the global economy remains in recession, might see the reasonably confident mood depicted in the minutes change quickly.”
Oliver sees scope for two more cuts from the current level of 3% as unemployment rises. “I’d lean to the view that rates will still come down a notch of two to 2.5% or 2.75%.”
As has been shown in recent days, the big banks have a very different agenda to the RBA – while central bankers need to protect the economy, the banks need to protect their margins and their shareholders’ interests.
This means there are no guarantees that the banks will pass on any official rate cuts, although it is likely that they would pass on at least a small part of any RBA cut.
However, Oliver points out that lower official rates should help stabalise rates. “I think the Reserve is still likely to cut the cash rates further and it should have the effect of keeping variable rates lower for longer.”
Of course, as Oliver says: “All this makes the choice between fixed loans and floating rates quite complex.”
That’s exactly the point made by Margaret Lomas, founder of property investment advisory firm Destiny.
She says she has never recommended fixing mortgage rates and it’s no different this time around.
“I just think that it’s madness to fix when we are in a stable or decreasing interest rate environment.”
Lomas says mortgagees and investors need to forget sentiment and focus on economic indicators, such as long-term bond rates and the outlook for inflation, which does not suggest that major interest rate increases are on the cards any time soon.
And if that doesn’t convince you, perhaps some simple maths will.
“The reality is the standard variable is 5.7%. If you take into account that most people can get at least a 0.7% discount then you are paying 5%,” Lomas says.
Now take the average fixed rate, which stands at 5.8% and appears to be creeping higher. “It will take us three official interest rate rises to bring us up to the fixed rate,” she argues. “That’s a fair amount more to be paying.”
Shane Oliver believes those looking at fixing should have acted a few months ago, when fixed rates were hovering at just above 5%.
“We are in the time-zone to be locking in. The best time would have been two or three months ago, but I think there will be another bite of the cherry later this year.”
If fixed rates fall again towards 5% – and he thinks it’s a strong possibility – then mortgagees should examine their options. “Unless you think the Australian economy is going into a depression and rates will fall through the floor, then you’re getting a very low rate. We’ve haven’t seen rates at 5% since the late 1960s. Given the RBA’s target range for inflation is 2-3% that means you would be getting a real interest rate of 2.5%.”
Michael Yardney, director of Metropole Property Investment Strategists, agrees that borrowers need to at least be starting to look at their options.
He says mortgage industry research shows that borrowers with the variable rate loans were better off than the borrower with the fixed rate more than 80% of the time, but this is usually because they fixed too late in the interest rate cycle.
“Generally the best time to fix is when the interest rate cycle is close to bottoming and [there’s] the prospect that cash rates will increase in the future. The current low interest rates are likely to only be seen once in a lifetime and there is already evidence that long term interest rates are at the bottom of their cycle.”
“Personally if I could get a fixed rate loan for 3-5 years around 5% and I thought we were at the bottom of the cycle, I would be fixing my loan.”
Yardney also points out that fixing rates is a good option for those who like to budget. “If you like the idea of knowing exactly how much you are paying out in your mortgage or investment loan repayment each month and not having the worry that your repayments may increase, then fixed rates are for you.”
It’s impossible to say definitively whether mortgagees should fix their rate or not – individual circumstances vary too widely.
But if you are considering fixing your rate, take your time, keep a close eye on the economy and watch to see if fixed rates fall back towards 5%.
While the banks have increased interest rates recently, the vast majority of economists expect a surge in unemployment will force the RBA to cut rates further in the next six to 12 months and this will put downwards pressure on variable and fixed rates.
Yes, interest rates will eventually have to rise from these historical lows. But as Michael Yardney argues, sticking with a variable rate pays off more than 80% of the time and you need to be sure in your own mind that the interest rate cycle has bottomed before locking yourself in.
James was the editor and publisher of SmartCompany and LeadingCompany for five years. He is now the Australian Financial Review‘s companies & markets editor, and a former BRW editor.
Comments