Call For A Quick Fix

Sydney Morning Herald

Wednesday October 25, 2006

By Denise Cullen

Fixed-rate home loans have been lower than variable loans but that may not last.

The mortgage belt is bracing itself for the possibility of another rate rise. But a growing number of people have twigged that fixed-rate loans are up to a half a percentage point lower than variable loans and taken advantage of it.

The official cash rate has been climbing steadily this year, rising by 25 basis points in May, and a further 25 basis points in August, taking the cash rate to 6 per cent. But there may be more of the same next month.

Locking in to a fixed-rate home loan, or at least splitting it between fixed and variable, is often a good way to peg payments to manageable levels.

And while the three-year-fixed loan has been about 50 basis points lower than the variable loan, that could change (see graph).

"If you're a borrower and you're thinking, 'Gee, I couldn't go another 25 or 50 basis points,' locking in provides a level of certainty," says Denis Orrock, the general manager of interest rate researcher InfoChoice. But you will need to act fast.

Many economists agree there's most likely to be a short window of opportunity lasting only a few weeks before fixed-rate loans start to rise too.

Fixed rates down

The situation where fixed-rate home loans have gone down while variable rates have gone up is "unusual" and is "unlikely to be very prolonged", says John Edwards, the chief economist at HSBC.

Fixed rates and variable rates are subject to different influences and pricing.

Fixed-rate loans tend to follow what's happening in the bond market, the market for longer-term securities that anticipate where rates are heading.

These are more strongly influenced by economic events overseas, particularly in the US.

Craig James, chief equities economist at CommSec, says slower economic growth in the US and lower oil prices contributed to an easing of longer term rates last month and early this month, which has had a flow-on effect on fixed rates.

Since August, says Harry Senlitonga, a senior research analyst with financial services research firm Cannex, money market rates (which set the pace for fixed-rate loans) have dropped from 6.51 to 6.26 per cent.

The average three-year fixed-rate home loan was 7.31 per cent the end of August compared with 7.21 per cent early this month.

"There may be ... a time delay between the money market rate and the reaction from lenders to adjust fixed-rate loans," Senlitonga says.

Variable rates are priced off the official cash rate, which is set by the Reserve Bank of Australia.

These are subject to the ebb and flow of short-term influences, such as inflation figures.

James says the previous rate rises have already "caused more consumers to get their finances in order". And for many, the plan involves locking in a fixed rate.

As the table on the opposite page shows, several institutions have fixed rates at just under the 7 per cent mark.

These are "very attractive", James says, given that they are lower than the standard variable rate of 7.82 per cent.

"Particularly given fears interest rates may rise again before the end of the year, any borrower who needs certainty in their home loan repayments [should consider fixing]," he says.

If you're one of them, it's important to act soon, as long-term rates have started going up globally during the past fortnight, reflecting growing confidence in the

US economy.

"Just as quickly as they came down, they're bouncing back again," James says.

"This reversal hasn't been priced in by institutions yet, but it will be."

Smart borrowers therefore need to take advantage of the favourable fixed rates available.

Changing trends

Australians are "irrational" in their abiding preference for variable-rate loans, Edwards says.

About 80 per cent of us typically opt for variable over fixed rates - the complete opposite of the pattern seen in New Zealand and the US - and at least part of the reason is our tendency to "overestimate the extent to which we can pay off

a home loan" faster than required, he says.

But the picture is changing, thanks to the series of rate rises we've seen. According to lenders, more borrowers are seeking, and signing up for, fixed-rate loans.

For example, during the past six months, Suncorp reports that the number of people choosing to fix their interest rate at its metropolitan Sydney branches has more than trebled.

Meanwhile, Bendigo Bank's fixed interest rates now make up 50 per cent of new consumer residential lending compared with 30 per cent a year ago.

Sapphire Mortgage Services, one of four lenders with a 6.99 per cent three-year fixed rate product, also claims to have seen a sustained trend towards fixed rates during the past six months.

"A large percentage of first-home buyers - currently almost 85 per cent - have opted for fixing at least some of their loan and in most cases this is at least 70 per cent of the loan," says Peter Brady, the managing director of Sapphire.

"First-home buyers have usually worked out how much they can afford to repay [and] want the security offered by a fixed loan that their repayments won't increase for at least a few years because they know they would struggle to meet increased repayments."

But fixed loans are not just for first-home buyers. Many borrowers who are refinancing to fund renovations, or upgrading to bigger and better homes, are also bracing for further rises by locking in fixed rates.

There are cons as well as pros associated with locking your loan in at a fixed rate.

Despite sentiment that another rate rise will be unleashed before Christmas, Orrock says that rates can move down as well as up and, if that happens, fixers might even end up worse off financially than those on variable rates.

Even allowing for that prospect, fixing your rate is still a good idea if you're worried about risk and exposure, he says, or "if you've already reached your maximum

pain threshold".

"You have to ask, 'What price do you put on being able to sleep at night?' " he says.

Finding the best lender

When choosing between fixed mortgages, there is much more to consider than just the interest rate.

Cannex's Senlitonga says the main thing borrowers need to consider when selecting a lender is that it is consistently competitive.

If the lender is luring consumers in to buy market share and clawing profits back later, the consumer may be worse off.

"Some lenders may offer a special rate this month, and [borrowers] decide to take the fixed-rate loan because of that, but along the track, when the fixed term finishes, the loan [reverts] to a higher rate relative to others," he says.

Another important point is whether you can make extra repayments. Orrock says fixed-rate loans are more flexible than they used to be but lenders vary considerably in terms of the features and flexibility they offer.

Senlitonga says out of the 128 three-year fixed-rate products available, 93 allow borrowers to make some form of lump-sum repayments (typically about $10,000 to $20,000 a year) while 42 have no restrictions on the size of the lump-sum payment.

"The ability to have a split loan would be a benefit for consumers who would like to get the features of both variable and fixed loans," he says. But make sure you are paying only one set of fees instead of two.

Fees for switching are something else to consider. Senlitonga says about

73 per cent of variable-rate products charge borrowers a fee of up to $800 to switch to a fixed-rate loan.

The break cost if you decided to discharge your loan or refinance to another lender is something else to watch out for.

"The size of the break cost will vary according to the amount of money that you pay early, the term remaining on your loan and the amount that interest rates have moved since the start of the current fixed-rate period on your loan," he says.

It's no coincidence, either, that non-bank lenders are among those with the best fixed-rate deals.

Orrock says that lenders such as Sapphire Mortgage Services operate on a lower cost base than mainstream lenders and so can provide fully featured products at a rock-bottom cost.

Sapphire's Brady says this flexibility is a function of the market becoming better educated and informed about home-loan deals, and more willing to consider a mortgage beyond the major banks.

WHY IT'S TIME TO BORROW SMARTER

When Glen and Margaret Redden first heard rumblings of an interest rate rise earlier this year, they did some serious number-crunching.

They'd just completed renovations on their Glenwood, NSW, home, pushing their loan with Suncorp just beyond the $300,000 mark and, with an eight-year-old to raise and two cars to maintain, they opted to borrow smarter rather than take the chance that they'd be forced into a bread-and-water diet.

After talking to their lender, they decided to fix the bulk of their loan. "That way it wouldn't matter if rates went up - we wouldn't come undone," says Glen Redden, 45, a software support consultant.

In August they fixed about 90 per cent of their loan at 7.1 per cent for three years, leaving the remainder of the loan on a 7.42 per cent variable rate. The switch cost them nothing, as the couple are on a professional package.

"Looking back, I'm very glad [we fixed when we did] because if interest rates go up even a quarter of a per cent, that means a lot over the longer term," Redden says.

WHEN TWO

BECOME ONE

The prospect of surviving on one income for the foreseeable future was a big part of the reason one young couple opted for a fixed-rate loan.

"We knew we'd be stretched for a couple of years and so it was safer to go fixed because then we knew we could afford it," says Tim Holman, 24, an electrician, whose wife Lila, 21, is expecting their first child next month.

The couple abandoned the rental roundabout when they learned Lila was pregnant and recently moved into a three-bedroom house in Sydney.

Seventy per cent of their $350,000 loan is fixed for four years at a rate of 6.99 per cent, while 30 per cent remains on the 6.95 per cent variable rate.

The Holmans originally sought finance pre-approval through a mortgage broker but they say they were attracted to the flexibility of Sapphire Mortgage Services and features such as the "fixed rate lock-in".

"[This allows] customers to lock in a fixed rate for three months while they are looking for a property, or to settle a refinance, without missing out on a competitive fixed rate during that time," Sapphire's Brady says.

According to Holman, he and his wife are already counting the savings this feature affords. Sapphire's fixed rate went up the day after they locked in a cheaper deal.

© 2006 Sydney Morning Herald

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