Last week Westpac announced it’s raising its variable mortgage rates on home loans and if history repeats itself, and it most likely will, other banks will follow their lead.
So, is it time to lock in and fix interest rates on some or all of your mortgage loans?
This is a question many property investors and home owners are asking, so how do you decide what’s right for you?
And what do you need to consider to ensure you make an informed decision?
Firstly, some background:
In a flat or falling interest rate environment Westpac, announced that it will be the first of the big banks to raise interest rates for owner-occupier home loans.
Over the past few months rates on residential investment property loans have gone up but the home owners have until now been shielded from an increase in variable rates.
The reason for the rise in interest rates is simple.
APRA has made regulatory moves designed to ensure Australia’s major banks are in the top quartile among their global peers – as recommended by the Murray Financial System Inquiry
As a result, the amount of capital that the banks need to hold against mortgages has increased by 50%. This was always going to come at a cost.
Some commentators suggest that Westpac’s decision to raise $3.5 billion through a share entitlement offer and increase its residential mortgage rate by 20 basis points was long overdue due to its significant exposure to residential property.
So Westpac didn’t raise its interest rates because the interest rate easing cycle is over. Rates are rising because the banks are adjusting to a new regulatory environment. The RBA hasn’t signaled any intention to start raising official rates any time soon.
There are three major implications arising from Westpac’s decision:
- It’s likely that other banks will lift interest rates on residential mortgages over the next couple of months. Westpac has set the benchmark and the other banks will eventually respond as they have done in the past.
- It further increases the likelihood that the Reserve Bank will cut interest rates again in the future. In fact, the money markets have factored in another rate cut before the end of the year.
- Westpac’s move will make it a sounder bank. With heavy exposures to mortgages, best practice means building extra capital buffers against a downturn in the property market. Higher interest rates make the bank and therefore our financial system a bit stronger.
Does this mean the property boom is over?
You’d think so considering the many headlines such as “Westpac rate rise ushers in end of the property boom.”
However, I disagree.
No one knows how things will pan out, but with a rate cut by the RBA almost certain in the next two months, overall rates will be marginally cheaper by Christmas.
You see… the RBA is likely to cut rates by 0.25% and over the next month Westpac’s rate will go up 0.20%.
For all intents and purposes, rates will really be much the same.
But the interest rates on business lending will be cheaper, hopefully boosting business lending and investment.
And by lowering the interest rate differential between Australia and the rest of the world there will be less demand for the Aussie dollar, meaning we should see the Australian dollar fall even further.
That would be a good thing for our exporters, including our farmers, and for tourism.
We’ll have more overseas tourists coming here to holiday because it will be cheaper for them.
At the same time more Australians will holiday domestically as overseas vacations will be relatively more expensive.
But this begs the question, if bank rates are rising what should you do with your loans?
Here are seven questions you should ask yourself when considering whether you should fix your loans:
1. Will I want to sell my property during the fixed loan period?
If so there could be a penalty for breaking your loan commitment.
2. Will I want to access the equity in my property to invest further during the fixed period?
Often this will come at a cost that may be prohibitive.
3. Do I need an offset account?
An offset account is a transaction account linked to your loan.
Many borrowers put their savings into this account and the credit balance here is offset against your outstanding loan balance reducing the interest payable on that loan. Most fixed rate loans do not allow an offset facility.
4. Can I make extra repayments off my loan?
As some lenders will restrict how much extra you can repay each year when you fix your loan, if you are able to save significant amounts you may consider leaving some of your mortgage variable and maximising the use of your offset account.
5. What balance of fixed and variable rates do I need for my portfolio?
Even if you only have one loan, you can usually split the facility with a portion being fixed and the rest being a variable loan, giving you the flexibility you need.
Often beginning investors choose to lock in 50% of their loans, while investors with larger portfolios protect themselves by fixing a larger percentage of their loans.
6. How long should I fix my loan for?
Now this is a difficult question, but if you believe that official interest rates won’t increase for a year or two and after that they will remain high for a number of years, then fixing for a short period such as one or two years may not make sense.
That’s because your loan facility will mature and revert to the prevailing interest rate at a time when they could be a few percentage points higher.
This is an area where you should take specialist advice.
7. If interest rates fall further, what will locking in today have cost me?
How would you feel if you’d locked in to a five-year loan facility and interest rates dropped further?
I know when I’ve been in that situation I took comfort in the fact that I was not trying to beat the banks; instead I had secured my cash flow position.
Yet I know others who have become stressed when rates turned against them.
Now a disclaimer…
I’m clearly no expert in this field (in the past I’ve often gotten the fixed vs variable decision wrong) so please get expert advice regarding your own circumstances.
There are many other issues to consider – things like your job security –and speculating on rate movements is fraught with danger and making a fixed versus variable decision for the wrong reasons can be costly.
While fixing your rate has the benefit of achieving “certainty” with your mortgage repayments, breaking a fixed rate loan can be costly as well as removing flexibility and control.
Choose wisely because you’ll only know if you’ve made the right decision in three or four years.
But remember rates will rise again one day and as fixed rates tend to rise well ahead of variable rates, it’s worthwhile keeping an eye on the leading indicators of our economy.
Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property. Subscribe to his Property Update blog.