With the RBA cutting the target cash rate by 4% since September 2008, and expectations of further cuts over the next two or three months, home loan borrowers have seen significant and welcome reductions to their monthly repayments. The question is now, how long will it last?

The answer is “not forever”, at least according to the Futures market. At time of writing, the 30 day interbank cash rate futures were factoring in a bottom in cash rates mid this year (1% below current rates), with rates starting to rise again in 2010.

Fixed home loans, which take their pricing more from the longer-term bonds available (which in turn are sensitive to inflation expectations), have also come down significantly from their highs of mid 2008. The key point to note though is that the bond yields tend to anticipate the direction of RBA rate movements. They started moving down before the RBA cut rates last year, and will likely begin to move higher again before the RBA starts raising rates back to a neutral policy stance.

For this reason, we believe that clients with variable rate loans should consider fixing a portion of their loans sometime in the next two to four months. During that period, it is likely we will see the bottom of the fixed rate cycle, with 3 year fixed rates close to 5%, and 5 year rates close to 5.5%. Although variable rates will appeal (maybe as low as 4.25%), the ability to “lock-in” a rate of 5.5% for 5 years should appeal to many.

 

However, there are important points to keep in mind before fixing. Firstly, be aware that fixed-rate loans are much less flexible than variable-rate loans. With most fixed-rate loans, you can only make relatively small additional repayments, and cannot redraw at all until it matures. For this reason it is almost always a good idea to leave some debt variable to retain those options.

Second, fixed rates can be expensive to exit should you need to break the loan before the fixed-rate period matures. The actual exit fee depends on how the lender’s cost of funds, margins etc have moved since the loan started, so is impossible to estimate in advance. However, it can easily run into the thousands of dollars.

Should you decide to move house, fixed rate loans are also more difficult to transfer between properties. In fact it is usually impossible unless you manage to organize a simultaneous settlement of the sale and purchase.

There may also be a fee payable to split your loan, and possibly additional account fees on the new sub-account – something to consider especially if the loan amounts are small.

Lastly, the fixed rate you receive may not be the rate you were originally quoted. Most lenders only set the fixed rate on the day they finish processing your paperwork, which may be weeks after your request. Almost all will however offer you the option to pay a “rate-lock fee” (usually minimum $500 or 0.15% of the loan amount), which ensures you don’t pay a higher rate than what you’ve been quoted. Usually this is a good option, especially when you average that cost out over a 3 or 5 year term.

At the moment there is a huge difference between the fixed-rates available across the major lenders, in some cases up to 1%. If you do consider fixing part of your debt, first ensure the fixed rate you’ll receive is competitive. Mat Carpenter is always available to quickly give you the current rates available across a wide range of lenders, and can help you calculate whether you are better off staying with your current lender or changing. Mat can be contacted on 92 333 888 or mcarpenter@financialkeys.com.au.

Matthew Carpenter

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The past few months has once again been categorised by investment market volatility as world markets come to terms with continued bad news coming from companies and governments.

Economic indicators over the past quarter have been poor. In December, unemployment increased in Australia to 4.5%. The news in the US was worse, where the unemployment rate rose to 7.2%.

Inflation continues to fall. The Consumer Price Index (CPI) in Australia fell 0.3% during the December quarter; the biggest quarterly fall in 11 years. The annual rate for 2008 stood at 3.7%.

The Reserve Bank of Australia (RBA) has continued with its strong rate cuts, in an attempt to stimulate the economy and bolster its resilience to the global economic slowdown. The RBA cut the official interest rate by 1% in December, and another 1% rate cut in February.

With the UK economy slowing sharply, the Bank of England continues to cut interest rates, with cuts of 1% in December, 0.5% in January and 0.5% in February. They are now at their lowest level in the Bank of England’s 315 year history.

Retail sales figures provided some positive news, with December retail sales in Australia ending up 3.8% compared to November in seasonally adjusted terms. When comparing retail sales for the previous December, the increase was 5.7%, suggesting that a combination of the government’s stimulus package and falling interest rates had made an impact.

US retail sales however, were not so positive, with sales falling 2.7% during December. This follows falls of 2.1% and 3.4 % in the previous 2 months.

In Asia, China’s economy grew 1.6% in December. While this is positive growth, it is significantly less than China’s growth over the past few years. The annualised growth for China is now 6.8%.

In Japan the economy continues to slow. Domestic demand has softened, as has demand from overseas. This has resulted in sharp falls in exports, imports and industrial production.

The International Monetary Fund (IMF) revised down its projected growth figures for most of the world’s economies (see graph below).

 

The credit crisis has more severely impacted economies than was previously expected. The recent IMF paper – World Economic Outlook Update – Global Economic Slump Challenges Policies, indicates that there was a lot more work to be done to get the world economy back on its feet. “A sustained economic recovery will not be possible until the financial sector’s functionality is restored and credit markets are unclogged”*. The IMF believes that governments and central banks will need to do more to assist the financial sector to deal with these issues as well as to help stimulate demand in the broader economy. “International cooperation will be critical in designing and implementing these policies”*.

The performance of equities for the quarter reflected the pessimism that continues in markets. International equities continued their downward trend, weighed down by the uncertainty of the size and duration of the global recession. There were periods of positive sentiment following announcements of large government stimulus packages. The uncertainty of when this stimulus will gain traction in the economy and the extent to which it will provide sufficient growth saw any initial share market gains dissolve. Recognition that the stimulus packages have not provided a silver bullet to the complex problems saw fear returning to markets, dragging them lower.

It will take time for these enormous stimulus packages to take effect in the real economy. When there are signs that these packages are working and more confidence returns, share markets may commence their long awaited rally.

The recent falls in international equities has been partially offset for Australian investors by the fall in the Australian dollar against many other currencies.

In Australia, poor economic data from Australia and abroad, combined with profit downgrades and capital raisings, dragged the share market lower. Australian real estate investment trusts also fell sharply, in contrast to unlisted property which has not been quick to revalue in any significant way.

The Australian Government bond yields fell during the past few months. In contrast, the yields on US Treasuries rose due to concerns over the supply for treasuries to fund the US Government stimulus package.

The general consensus at present is that share market volatility will continue for several more months while companies and countries steer their way through the financial crisis. While many assets are valued at attractive levels, the timing of the next market rally is impossible to predict. Investors’ patience is being sorely tested, however eventually it will be rewarded.

*IMF — World Economic Outlook Update — Global Economic Slump Challenges Policies, 28 January 2009.

Brendan Gallagher

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Tax-free Cash Bonus

As part of its $42 billion “Nation Building and Jobs Plan” the Government has announced tax-free cash bonus payments for low and middle income households and individuals. There are a number of different payments directed to support different groups.

Tax bonus for working Australians - You must meet all of the following criteria to be eligible:-

• your 2007-08 taxable income does not exceed $100,000
• your adjusted tax liability for 2007-08 is greater than zero (that is, you paid tax)
• you lodge your 2007-08 tax return by 30 June 2009, and
• you were an Australian tax resident for the 2007-08 financial year.

The maximum bonus of $900 will be paid to those earning $80,000 or less; people earning between $80,000 and $90,000 will get $600; and those earning between $90,000 and $100,000 receive $250. This will support up to 8.7 million individuals.

Other bonus payments available include the following:-

• $900 single income family bonus to support 1.5 million families with one main income earner. It will be paid to recipients of Family Tax Benefit Part B between 11 and 20 March 2009.
• $950 per child back to school bonus to support 2.8 million children from low and middle-income families.
• $950 farmer’s hardship bonus paid to around 21,500 drought-affected farmers and farm dependent small business owners receiving exceptional circumstances related income support.
• $950 training and learning bonus paid to students and people outside of the workforce returning to study to help with the costs of education and training.

Tax Commissioner Michael D’Ascenzo said most eligible people would not have to do anything to receive the proposed payment. The Australian Taxation Office (ATO) would use information in people’s 2007-08 tax return to work out who was eligible and the best way to get the payment to them.

Payments will begin being made from early April 2009. Taxpayers who have not already lodged their 2007-08 income tax return need to do so by the end of June 2009 to receive the bonus.

Minimum Pension Reductions

The Government has temporarily suspended requirements for people on superannuation pensions to make a minimum annual withdrawal from their accounts.

The Government has eased the rules in response to the collapse in the value of individuals’ superannuation fund balances as a result of the Global Financial Crisis. The initiative is aimed at helping retirees reduce the decline in account balances but is of little use to those who are already at the minimum they need to meet living costs.

The drawdown relief allows eligible superannuation pension recipients to elect to cease or reduce the amount of pension payments that they receive for the remainder of the 2008/09 financial year. The total pension received for the year can be reduced to one half of the yearly minimum. If half of the minimum has already been drawn then the pension can be switched off for the remainder of the financial year.

Currently a Centrelink customer is treated as receiving at least their regulatory minimum pension amount. Our understanding is that the drawdown relief will flow through to the social security income test for income streams at Centrelink, and Centrelink will be able to recognise an actual amount being received below the current minimum.

Example - No further pension payments required for the rest of 2008/09
Mrs Smith is aged 67 at 1 July 2008 and had an account-based pension with an account balance of $100,000 at that date.

The minimum annual pension calculated for Mrs Smith on 1 July 2008 for the 2008/09 financial year was $5,000 ($100,000 X 5%). Mrs Smith has been taking quarterly instalments, and up until today Mrs Smith has received $2,500 in pension payments.

Based on the drawdown relief, Mrs Smith’s annual minimum pension requirement for 2008/09 is reduced to $2,500 therefore she can elect to have no further pension payments for the rest of 2008/09.

Andrew Condell

 

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