Who has the best rate?
Why has such a simple question become so complicated?
Once (many years ago) the Reserve Bank set the Official Cash Rate. The Official Cash Rate acted as the accelerator and the brake for the economy – a lower rate stimulated the economy, higher suppressed it.
A low rate makes it easier to borrow, both for houses and for business. Low rates stimulate property purchase and this has a multiplier effect in the economy. The building industry is stimulated, employing many people. New home buyers shop for furniture and homewares, stimulating retail. Home owners or Investors borrow for improvements and renovations. House price goes up and people have created wealth, which stimulates spending… and so the world turns ...
Immediately post GFC (now 10 years ago – 2007) central banks worldwide lowered rates to stimulate a world economy that had stalled.
In the GFC some world banks had failed. Here in Australia – Bankwest (owned by Lloyd’s of London, which collapsed) was bought by CBA. St George was sold to Westpac. RAMS (a good example of why you, as a borrower should never borrow from a non-bank) was unable to renew its funding – because its European backer collapsed – and so did RAMS. The good loans were sold to Westpac and the bad loans had their rates increased until people could refinance elsewhere. Macquarie deserted its own customers, ceased home lending, and trapped its customers with high rates. It was a difficult time.
Up until the GFC – The Banks passed on the Official Cash Rate, plus a margin which varied from bank to bank. This margin also varied by loan size. The bigger your loan, the lower your rate – customers who brought more profit to the bank were rewarded. Loan size was the first price lever.
Post GFC a double price lever was introduced to reward customers who brought a bigger deposit and hence a lower risk to the bank.
- The bigger your loan the lower your rate
- The bigger your deposit the lower your rate
- Bring BOTH to a bank and you were doubly rewarded
Closer to home, the mining sector was beginning to wind down. To soak up the many employed in mining construction (and keep the unemployment rate down), Governments of the day encouraged residential construction of high density, high rise apartments.
The Reserve Bank, who had misread the world economy and had been raising rates into the GFC, cut rates rapidly. A housing boom was created – deliberately.
Anyone who could buy, was encouraged. At the same time, people were being told there would be no old age pension until much later in life. Investors – both here in Australia and from overseas were the obvious buyers.
As with all good parties, early in the night everyone has a good time, later in the night though – things can get a little out of hand.
Enter stage right – two new players in the interest rate scene – they are called the party poopers. They are BOTH arms of government. It is no use complaining about the party poopers because the government is directing them
APRA – designated to manage the stability of the whole financial system – can cancel a bank’s licence. Banks MUST listen to APRA. APRA directed banks to do two things
- Slow down investor lending to no more than 10% growth per annum
- Raise extra capital for a future GFC
Banks came up with a clever plan … add another new price lever.
- By increasing rates for investor loans – they could disincentivise investor loans and raise capital at the same time
- They even tried to look slightly sad while they did it .. pardon my cynicism
ASIC – has a role to “protect” consumers – and has a specific role to oversee consumer law in the lending industry (NCCP) Anyone who sells loans must have a licence (ACL). Anyone who falls foul of ASIC can have their licence terminated. Banks and brokers alike MUST listen to ASIC.
ASIC took the view that some Interest Only loans were being inappropriately sold. An investor product was increasingly being sold to owner occupiers. Remove the compulsory “P” from P&I and the repayments drop. Why is that potentially bad? The sting in the tail is that after the I/O period, the loan still has to be repaid in the original loan term. Peter has been robbed to pay Paul. Lower repayments in the short term jump markedly at the end of the I/O term.
ASIC took to visiting every bank – yes – door to door visits. ASIC took to scrutinizing lenders loan books. If ASIC decided that the bank was inappropriately approving I/O loans to owner occupiers, then ASIC threatened to cancel their ability to sell loans at all!!
Banks came up with a clever plan … add a new price lever
- By increasing rates for interest only loans – they could disincentivise interest only loans .. and make more profit at the same time
- They even tried to look slightly sad while they did it … pardon my cynicism
My personal view is that there are sensible reasons behind the current price levers – but every time a bank becomes “responsible” their profit goes up. This is because their cost of funds is independent of these factors. Banks simply alter the price to slow the sale of certain products.
If we wish to point the finger of blame for the two new price levers though – we must go back to the source – APRA (responsible to Treasury, responsible to the Treasurer – this is the government of the day) and ASIC (a statutory body answerable to the Parliament as a whole). Government policy is creating higher rates than need be.
So, for 2017 who are the players in the game for setting the price of interest rates.
- Wholesale funders worldwide**
- The Reserve Bank
- APRA
- ASIC
** There are signs that the USA funding market will increase in price post Donald Trump. USA cash rate seems to be increasing (but still only 0.5%) The European Central Bank still has a bond rate of 0%, Japan still has a bond rate of 0%.
Here’s the weird thing
- The Reserve Bank still has its foot on the accelerator
- APRA and ASIC have their foot on the brake
The Reserve Bank is trying to stimulate the whole economy.
APRA and ASIC are trying to slow investment lending.
The government would like to create “jobs and growth” – remember that one? So we would like to have jobs in construction, but restrict a whole class of people who would buy the product.
Confused? – well join the club
The key message for 2017 – is not to listen to noise. There is going to be lots of noise! Journalists must write something every day – the story should sound compelling and new. Better still if the story is dramatic!!
What will happen to rates in 2017?
The Australian economy is barely spluttering along; housing is still one of the main bright spots. The Reserve Bank will be most reluctant to raise rates – it will talk a lot and do little (if anything) in 2017.
APRA and ASIC will continue their current roles – this will fade in time – but not in 2017
The world will continue to give mixed messages
What will happen to rates in 2017? Very little – and possibly nothing
Of the future - past 2017 – rates will eventually rise, albeit slowly.
You should stay above the noise and plan … plan now for the top of the next interest rate cycle.
I could not possibly know what the top of the next cycle will be (or when) – but my prudent suggestion is to give yourself certainty for now, by increasing your own interest rate – get ahead of the game.
Set your own payments “as if” your interest rate is 6%
Overpay your loan.
- Any extra comes straight off the principle – that’s a plus
- Any extra can be redrawn in a rainy day situation – that’s a plus
- You have future proofed your budget by preparing for what your payments need to be
FIX YOUR REPAYMENTS NOT YOUR RATE
Many people will listen to the media noise and be tempted to fix their rate. The logic is seductive. Your budget is fixed … BUT
- Your fixed interest rate will be higher than variable, so you are paying a premium for peace of mind– thus throwing profit at the bank.
- You will be restricted in what you can pay back – why would you do that?
- Even if you can pay a little extra back – you cannot draw it back when a rainy day comes – how is that of any help?
- If a better offer comes along elsewhere – you can’t take it because you fixed.
- You have a false sense of security – because you can only fix for a defined period – and after that you must renegotiate your loan with a bank with zero bargaining power.
2017 is definitely the time to plan for the future. Your circumstances are of course specific to you. I am happy to talk through your own needs with you personally
I am often asked who has the best rate – such a simple question - but the answer requires an understanding of your own needs. This is much more complicated than most people realize – that’s why it makes sense to Ask Alan.
I will find the best loan for your specific and personal circumstances.
As always you can call or email me anytime... 0411 601 459... Just Ask Alan