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A question on interest rates

Discussion in 'Real Estate' started by cescae, 20th Apr, 2009.

  1. cescae

    cescae New Member

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    Hi
    I'm wondering if any of you informed and educated people could tell me what happens if you have a variable home loan and the official interest rate bottoms out at 0%. How do the banks stop everyone from fixing their loans at the bottom rate? There is obviously nowhere to go but up so do the banks then raise their fixed rates further to deter those of us who have hung-on to fix our loans at the lowest rates? :confused:Does anyone know what has happened in other countries?

    thanks for your feedback:D:D
     
  2. AsxBroker

    AsxBroker Well-Known Member

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    Hi Cescae,

    There is a difference between the official interest rate and lending rates.

    In the US the official rate is between 0 to 0.25% (I don't know how they get a range...probably for different rated banks) and then lend out at a higher rate, eg, Citibank in the US is charging approx 4% pa interest on home loans. The difference is commonly known as "the spread", this is the difference on which the lender is making money.

    In Australia the official interest rate is 3% and most home loans are approx 5% or so. Hence "the spread" is approx 2% in Australia.

    So if official interest rates (which they have in the US) drop to 0% in Australia you can rest assured that your lender will still be charging you interest based on their spread.

    Also banks are usually pretty smart the banks loans for long term fixed rates are significantly higher than the variable rates. Eg, CBA 15 year fixed loan is 6.99% (as at 21st April 2009).

    Nobody thinks the economy is going to recover quickly so paying 2% above the variable loan could be considered expensive as there could be a long wait for it to catch up.

    Cheers,

    Dan
     
  3. cescae

    cescae New Member

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    to fix or not to fix?

    Hi
    Thanks for your response ASXBroker:)
    I do realise that there is a difference between the official rate and the lender rates.. What I was wondering is whether this rate gap increases as the official rate heads further south.. The reason I'm asking is that I have inquired about fixing our rates on a number of occasions and I feel there is a pattern emerging....
    It looks to me as if the lender 'ups' the fixed rates when they believe people will be thinking about fixing them - ie when the interest rates are going to start rising again. I could be wrong in this but what i'm thinking is that if we leave fixing our interest rates until the official rate 'bottoms out' then we will be cornered into taking a higher fixed rate anyway? (as the only way is up and everyone will be wanting to fix at the lowest rate possible)

    Our lender only passed on a .1% cut with the last interest rate cut (and our current no-doc loan now sits at 7.05%) so I figure even if the interest rate drops by another maximum 3% -chances are we'll only see a maximum of 1% - and thats highly dubious! At the moment we can fix our rate at 7.49% for 3yrs (on an interest only loan which becomes interest and principle after 3yrs). I am hoping that the market will recover enough to sell our house in three years...

    I'm concerned if we wait for interest rate cuts - that may not even be passed on - that we will miss our 'window of opportunity' for fixing at a relatively low rate and then we'll be dragged pretty speedily back up to the 10% mark when the interest rates turn around - perhaps due to inflation -as people keep saying. Then we will be stuck paying a higher rate of interest and the principle. :(
    Cheers
     
  4. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    This is the decision that everyone faces - and unfortunately you won't know which was the correct decision until well into the future.

    The problem with fixing is that you miss out on the cheaper rates for the whole period that variable rates are lower than fixed - which may be several years yet. It may well cost you more overall to fix - even if rates do go higher for a while.

    The key with fixing rates is to not look at it purely from the basis of spending the least amount of money. Fixing rates is a risk management strategy - not a cost saving strategy.

    Fixing rates is like taking out insurance. Given that you are statistically unlikely to need to insure your house against fire (assuming you don't live in a bushfire prone area) ... means that you can indeed save money by not having insurance. But that doesn't necessarily make it the right decision - you take out insurance to cover for the unforseen events, those events where you fall on the wrong side of the statisticians tables and which may be catastrophic for you financially if they did indeed come to pass.

    Similarly with interest rates - if you don't fix, you may well save money, but you may also end up paying a lot more if interest rates do indeed go very high in the future.

    The downside to fixing rates is the reduced flexibility you get with refinancing your debt. The break costs in fixed loans can be quite severe such that if your circumstances change, or you simply want to make changes to your loan ... it adds even more cost if you have fixed.

    There is no right or wrong answer - it depends on your own situation and plans.
     
  5. Chris C

    Chris C Well-Known Member

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    I think it is a fairly safe assumption to expect the gap to widen as the cash rate drops. That said I also expect fixed rate loans to fall as the cash rate falls.


    Whilst it is hard to speculate with confidence on this issue given the Australian banking system has never quite been through a situation like this before, but I'd expect that when the monetary policy easing has stopped (whether it be at 0% or some rate above 0%) that fixed rates will be lower than they are today.

    I don't know what you circumstances are but according to rate city there are a number of loan providers that are offer 3 year fixed loans at 5.3% to 5.6%.

    Home Loans - RateCity.com.au

    I think you will find that they will be passed on when banks can afford to pass them on. I expect that with each passing rate cut most banks will continue to pass on at least a portion of the rate cut.

    I wouldn't be too worried about missing the boat either, I don't think the upswing in interest rates will be particularly quick because I have my doubts about whether the recovery will be particularly quick given that most economies around the world are well and truly in recession and have been for some time, both consumer and investor confidence has been smashed and very few will be making big consumption and investment decisions with the former irrational exuberance we showed before mid 2007.

    So if confidence is slow to return then the recovery will also probably be quite slow, and the longer the global recession drags out the slower the recovery is likely to be.

    Also I think it is important to remember that with 70% of Australian households living in their own homes of which the majority paying off a mortgage on a variable interest rate, you can rest assured that whatever happens with interest rates the majority of Australia will be in the same boat as you.

    What that means is, if you are worried that you might struggle to be able to afford paying high interest rates, it is reasonable to expect that the majority of Australia will be also struggling, meaning that the economy will struggle which will mean that the RBA will be inclined to reduce rates to stimulate the economy. Alternatively if you think rates will become high because of high inflation then it is also likely that house prices will rise due to inflation along with incomes making your ability to pay your loan slightly easier.

    Economics and markets are always about finding equilibrium. So if you make sure you are putting in an above average work getting above average pay you can rest assured that through the process of the competitive market place you should pop out the other side alright.

    So from my perspective the most important thing is to not make rash decisions or panic. At this stage I would say time is on your side. I'm also looking at fixing my rates in the not too distant future, but I expect that over the next 6 - 9 months it will be clearer as to how this whole episode is going to play out. Right now there are just too many uncertainties to want to commit to anything (but that could just be my commitment phobia talking :p).
     
  6. cescae

    cescae New Member

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    sitting pretty

    hello
    Thanks for the responses again:)
    It would seem that the majority think that sitting tight for the immediate future is probably the safest/wisest thing to do.

    One question however..
    Chris, you said that we could perhaps get a lower fixed rate with another lender... Can we do that if we are on a no-doc loan? Wouldn't the no-doc loan rates be higher? and what would be involved with transferring the loan over to another lender?

    Cheers
    :D
     
  7. Chris C

    Chris C Well-Known Member

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    I'm probably not the best person to be asking about the technicalities of loan agreements. I'd either recommend speaking to a good mortgage broker who can do the hunting around for you or maybe one of the other members here might have some experience they could share in regards to no-doc loans.
     
  8. sav

    sav Member

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    Thought I'd bump this thread since we now have interest rates at historic lows, and I guess the likelihood is the rate-cutting cycle must be getting close to an end? And my understanding is fixed rates move up prior to the cash rate and hence variable rates. With 3 year fixed rates still below the variable rate, are people thinking about fixing now/soon?
     
  9. Chris C

    Chris C Well-Known Member

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    I don't know about you but I'm not sensing that good times are just around the corner - and until the average Joe Blow starts feeling that I suspect that interest rates aren't going north anytime soon.

    So unless you have a compelling reason to fix I don't see much point.

    Give the bank's some credit - the real reason the fixed rate is still below the variable rate because banks still think the future will be gloomier than brighter...

    ;)

    Always remember, banks are in the business of making money. So if they do things - they do it for a reason.
     
    Last edited by a moderator: 20th Sep, 2013
  10. jodie123

    jodie123 Active Member

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    I can't see rate rising anytime soon (within the next year or so at least). The dollar is climbing again and I'd bet that we may even be looking at another cut on Melbourne Cup day.
     
  11. Chris C

    Chris C Well-Known Member

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    I agree the dollar moving up definitely increases the "chances" of a rate cut - that said the dollar is still 10% below where it was a few months back and interest rates have moved lower throughout the year...

    So I'd like to think that the Australian economy headwinds aren't too strong at this stage and that we won't need another rate cut - at least we won't need one without some major negative news coming out of the US, China or Europe.

    :rolleyes:
     
  12. sav

    sav Member

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    So 3 of the majors have started raising their fixed rates. I can still get a .31% discount from the variable rate for a 2yr fix on my loan, or .16% for 3yr. Fixing some of my loan for 2yrs will save me money and even if there's a .25% cut I'll still be better off. I'm thinking I'll fix 25-50% of my loan rather than paying a premium for the ability to benefit from further possible (unlikely?) drops in the next 2-3yrs. What are your views?
     
  13. Chris C

    Chris C Well-Known Member

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    Yes bond rates in Australia, US and UK have been drifting upwards, arguably suggesting a slow return of confidence, but it's still the same situation - banks know more than you and I - and what will happen over the 12 - 24 month time frame is anyone's guess.