With an interest rate rise last week and the banks proving they are happy to move out of step with the Reserve Bank, many property owners will be wondering whether they should lock in the rate on their loans.

Fixing your interest rate provides certainty that the repayment amount for your loan won’t change, regardless of whether the Reserve Bank changes the official interest rate.

It is important to remember lenders are in the business of making profits by selling money. They are making a bet that the variable rate loan on average will be lower than the fixed rate they are offering and they rarely lose.

When you take out a fixed rate loan, you’re effectively paying a small insurance premium to protect yourself against repayment increases.

Most fixed rates run for one to five years, although some lenders offer 10- to 15-year terms. The longer the fixed-rate term, the higher the interest rate, because it becomes harder for the lender to accurately project the direction of official interest rate movements.

Generally speaking, fixed-rate loans differ from variable rate loans in a couple of ways. First, there is a limit to how much principal you can pay off. The ceiling for making additional repayments is usually around $5000-$10,000 a year above the minimum required amount.

In addition you may pay a penalty if you break a fixed-rate term and switch to a variable rate. If the official cash rate has dropped since you took out the loan, the variable rate will have dropped. The lender will incur a loss in comparison with the initial profit margin they set when you took out the loan, so they will charge a fee to compensate.

There is no hard and fast rule about whether, and when, it is appropriate to fix your interest rate. However here are a few general guidelines.

If you have debt on your family home and debt on an investment property, it may be wise to consider fixing your investment loan. This will enable you to focus on reducing the debt on your family home. Debt on your home should always be paid off first because it does not attract an income tax deduction.

Further if you’re self-employed and don’t have a regular income, fixing your loan may help you manage your cashflow.

If you do decide to fix your loan, it may be sensible to fix only a portion of it and put the rest of your borrowings in a separate variable loan facility. The usual split is 50 per cent fixed and 50 per cent variable, though this isn’t set in stone.

Splitting your borrowings enables you to make unlimited additional repayments on the variable component so you can reduce debt more quickly.

In the end, deciding to fix your loan comes down to your personal situation, how much debt you have and whether you think that obtaining certainty in your repayments is worth the risk of paying a premium if the official interest rate falls. Even if your friends or family are fixing their loans, it might not necessarily be the right move for you.

Mark Armstrong is a director of Property Planning Australia (NSW), www.propertyplanning.com.au  

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Australian banks’ preference for writing home loans rather than lending to business may pose a risk to the banking system and the overall economy, according to a leading banker.

Joseph Healy, business banking head of National Australia Bank, said the bias of banks toward retail mortgage lending could hobble the economy’s long-term growth by skimping on loans to small businesses. The money flowing into housing may create other distortions such as fuelling excessive investment, he said.

”With the apparent bias towards to the household sector, we shouldn’t discard the possibility of asset bubbles being created there,” Mr Healy said.

”We’re not saying we believe there is an asset bubble but shouldn’t close our minds to the possibility of that happening.”

Since the emergence of the global financial crisis, small businesses have complained that they have borne the brunt of tighter lending requirements, with interest rates on their loans falling less than other borrowers. In addition, competition among banks has been reduced as several smaller lenders either exited the market or where swallowed up by bigger rivals.

Mr Healy said banks’ tilt towards home loans meant fewer loans are available for business, effectively crimping the economy’s growth engine.

”This is ultimately bad for growth, bad for competition, bad for jobs, bad for business and in the end bad for Australia,” he said.

In 2000, every $1000 of home lending was matched by roughly the same amount for business. That ratio has since shifted so that today, for every $1000 of home lending, only about $600 is available for business, according to NAB research.

Home lending comprised 43 per cent of the lending of the big four banks – Commonwealth Bank, Westpac, NAB and ANZ – in 2000, but rose to 57 per cent this year. In the same time, business lending has dropped from 46 per cent to 35 per cent, according to NAB’s figures.

”The lack of access of finance has been a problem but also the cost of finance,” said Peter Strong executive director of Council of Small Business of Australia.

Banks are currently charging as much as 2 percentage points more than the standard mortgage rate to many small businesses, Mr Strong said.

Among the big four banks, NAB has the largest small-to-medium business loan book and the smallest residential mortgage book.

Most-overvalued market

In contrast to the trends in most rich nations, Australia’s house prices have continued to rise even during the global economic slowdown. Analysts have cited loan availability but also a relatively strong economy and a shortage of affordable stock for the divergence.

Some of that price fizz is coming off, though, with home price growth moderating in the past few months. Even so, the recent prices gains have pushed the national city median home price to $468,000, according to RP Data-Rismark.

The Economist magazine last week said a ”fair value” analysis of global property shows Australian property the most overvalued of any of the 20 countries the publication tracks, based on a comparison of the current ratio of rents to prices to a long-term average.

Mr Healy’s comments come as analysts speculate that Australia’s major banks may be squeezed in coming months by rising off-shore funding costs, with the banks’ exposure to the residential mortgage market drawing greater scrutiny on global markets.

Mr Healy delivered a speech on business lending to the American Chamber of Commerce in Sydney this afternoon.

Professor of Economics & Finance at the University of Western Sydney Steve Keen lauded Mr Healy’s comments.

”I’m delighted to see somebody in the banking sector come out and say this because it’s really about speculation being funded by the banks rather than investment.”

”To me the essential thing banks should be doing is providing working capital to firms.”

Story by Chris Zappone – czappone@fairfax.com.au

S&P credit ratings expert confirms the strength of the housing sector but questions the benefit of high home prices for society

A managing director of a credit ratings agency responsible for scoring the quality of Australia’s mortgage debt has questioned the social impact of the nation’s soaring house prices, even while she confirms the strength of the sector.

Standard & Poor’s managing director of rating services Fabienne Michaux said the strength of Australia’s mortgage quality is a success on the capital markets but the high valuation of homes underlying the debt presents a long-term risk to the basic fairness in society.

"The social implication of house prices in the longer term is a key issue," she said. "One of the things people were proud of was that (Australia) was fairly egalitarian and even and everybody had basic rights to housing and basic education and good healthcare."
"Those are the sorts of things that start to chip away when you’ve got people who can’t afford to actually to find somewhere to put a roof over their head."

The median national city median home price was $468,000 in May, according to RP Data-Rismark, following years of nearly uninterrupted increases in value, driven by a shortage of available new land, a cumbersome building approvals process and tax incentives that reward owners to purchase and hold second homes.

There is an estimated 200,000 home shortage in the nation, expected to worsen as a recovery in building stalls. Ratings agencies such as Standard & Poor’s grade the quality of the mortgage debt that is repackaged and on-sold by local lenders to institutional investors.

While confirming the strength of assets underlying Australia’s residential mortgage backed securities market, which has issued $352 billion since 2000, Ms Michaux noted home owners are unwise to take too much satisfaction in becoming property millionaires.

"Ultimately the utility of the house is still that you’re living in it," she said. "When you pass it on, it’s still one house. If you’ve got two kids you’ve got half a house each."

Story by Chris Zappone Fairfax Digital

Borrowers are unlikely to get any respite from lower borrowing costs for the forseeable future as the big banks continue to replace tens of billions of dollars of cheaper-priced debt at much higher rates.

That was underlined by ANZ yesterday when it disclosed that the new long-term debt it is taking on is costing 20 per cent more than the average price across its $90 billion portfolio of borrowings that extend to the 2014 financial year.

ANZ told investors in London that while funding costs had dropped since the peak of the global financial crisis, pricing remained high and would continue to rise as the bank looked to replace another quarter of its long-term loan book.

Like its big four counterparts, ANZ has been paying as much as one full percentage point more than such debt was costing in the economic boom years before late 2007.

At the height of the crisis and when the federal government’s AAA credit rating was required to guarantee new bank lending, the industry was paying as much as double that to keep wholesale financing sources open.

That situation has eased and the big banks have been able to cut their reliance on government-guaranteed debt – and the price they pay to use it – by using their own AA credit ratings to obtain replacement funding as their borrowings have matured.

Banks have typically borrowed from domestic and overseas investors for two to three years but have been extending these times to about five years to lock in secured funding at fixed rates.

ANZ said yesterday that five years was now the average compared with 3.9 years in 2009, though this would come at a higher cost. At the same time, it had raised 70 per cent of its target of $25 billion for the 2010 financial year, which it estimates it will need to meet customers’ loan requirements in the next year or so.

But the high price of the debt will continue to feed through to interest rates on individual loans such as mortgages, personal loans and business credit, market watchers say.

According to figures compiled by BusinessDay, between now and September next year the banks need to replace long-term funding of the equivalent of $125 billion in pre-financial crisis terms.

Such an amount leaves little scope for loan rates to be eased with the banks looking at any opportunity to pass on higher funding costs to customers.

But after some banks’ controversial decisions of the past two years to increase the price of standard variable mortgages above the cash rate, the big four have kept their increases in line with the rises in official interest rates.

Story by Danny John – domain.com.au