Home Loan Rates – Is the boat about to leave?
by Matthew Congiusta
Australia’s Reserve Bank (RBA) cut the official interest rate in August by 0.25% to 2.50%, the lowest level in over 50 years. The major banks have predominantly passed on this cut by reducing their mortgage rates for home owners. This article will examine why is it that rates have fallen as far as they have, what is the outlook for interest rates in Australia, and finally what people with home loans should be doing to take advantage of the current low-rate environment.
Australian Cash Rate
*Calculated using average of weighted median and trimmed mean inflation
Sources: Australian Bureau of Statistics, Reserve Bank of Australia
The above chart shows how the Australian cash rate has moved over the last 20 years, to the current level of 2.50%1. To put this into perspective, interest rates in many of the major economies across the globe are also at all-time low levels. A number of central banks have implemented quantitative easing programs and cut interest rates in the hope of generating growth, spurring on economies and promoting investment post the Global Financial Crisis (GFC).
In Australia, following the massive rate cuts during the GFC, the economy continued to power along, with strong Growth Domestic Product (GDP) growth leading to inflationary pressure. This forced the RBA’s hand and interest rates were increased between late 2009 and late 2010, in this period we saw seven rate rises1. Following the slow-down of the resources boom, Australian economic growth slowed, reducing inflationary pressure, allowing the RBA to reduce rates to the current level. In this period we have seen eight rate cuts since late 20111.
The chart below shows the cash rate futures yield curve which is basically a prediction of where the cash rate is expected to move over the next 12 to 18 months. Although this cannot be relied upon as an exact indication, you can see that the general consensus of the market is that rates in Australia may increase between the end of 2014 and half way through 2015. As shown in the chart, the market has firmed in its view that the RBA have come to the end of their easing cycle, however there are reasons to suggest that there may be potential for a further small cut.
ASX 30 Day Interbank Cash Rate Futures Implied Yield Curve
As at market close on 18 November 2013
Source: Australian Securities Exchange (ASX)
At the November meeting, the RBA board chose to leave the cash rate at 2.50%. It was noted that forecast public spending was quite weak and the currency is ‘uncomfortably high’. In this environment, with inflation at 2.2% which is at the lower end of the targeted range i.e. between 2-3%, monetary policy remains a primary stimulus tool2.
Pending economic conditions in Australia, it is uncertain as to what the RBA will choose to do with interest rates in the short term. However, over the long term, once Australian GDP growth picks up, leading to increasing inflation, the RBA will likely raise rates once again to help ensure that inflation levels remain in the targeted range.
So what does this mean for those with hefty home loans? Mathew Carpenter of MGC Finance makes the following observations:
"What I've noticed in the past is that the direction of change (i.e. moving up, or moving down) in available fixed-rate home loans tends to reverse several months before the RBA changes the direction of its rate movements. At the moment, after a long period of banks reducing the fixed-rates on offer, we are now seeing fixed-rates on new loans starting to rise again. This would indicate that the bond-markets believe the next move by the RBA is expected to be up, not down. There are still some incredibly cheap fixed rates available, but they're getting harder to find.
I do caution though that fixed-rate loans have downsides, and it's important to understand the risks associated with them before deciding whether or not they are suitable. The main risk is that if you need to repay the fixed-loan before the fixed-period has matured, you can be up for large penalty costs. Clients really must speak to a mortgage broker before just calling their lender to switch to a fixed-loan."
It may be an opportune time to move ahead of the curve by locking in fixed rates. But this would assume that locking in fixed term mortgage rates are always the best solution. Here is a simple list of things to consider if you have a home loan:-
Have a reputable mortgage broker review your home loan and evaluate your options. This can include any features that may be suitable to you (such as an offset account), as well as your strategy which may include whether to fix a portion of your loan. Mortgage brokers typically have more lenders to choose from than your bank. If you don’t have a mortgage broker, contact Financial Keys.
If the advice you receive is to move your home loan to a different lending institution, ensure that there is a reasonable NET saving to you i.e. make sure that the interest saving by moving lenders isn’t eroded by increased fees or switching costs.
Consider whether, based on your financial and personal situation, it would be suitable to lock some of your home loan into a fixed rate/term loan. This will depend on a number of factors including your future borrowing requirements, cash-flow requirements and stability of income. If you require assistance with this, contact Financial Keys.
Just like extreme investment market environments provide opportunities for those with their eyes wide open (e.g. buying growth assets in the middle of the GFC in 2009), the historically low interest rate environment we find ourselves in currently, is a significant and potentially once in a lifetime opportunity to save a significant amount of money. Don’t miss the boat.
1 Reserve Bank of Australia, www.rba.gov.au
2 Van Eyk – Investment Outlook Report, November 2013
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