Home Loans

Sydney Morning Herald

Tuesday September 1, 1992

Peter Freeman

THE arrival of spring marks the start of what traditionally is the strongest three-month selling period for the housing market. Attracted by the warmer weather, home buyers pour into the houses and home units on offer and flock to the auction rooms.

In some situations this can result in a big lift in both sales and prices but not necessarily. While there is little doubt that the next three months will see a rise in the number of homes actually sold, an increase in the number being offered for sale well may keep the lid on prices.

As well, many who go to inspections or attend auctions are "just looking"while some are interested in buying only at fire-sale prices. Others, this year, will be keen to buy but will hold back due to the continuing economic uncertainty and concern over unemployment.

But irrespective of what happens to real estate prices one of the most pressing issues of all - both for those who are about to buy and people with existing mortgages - is the question of what is likely to happen to home loan rates.

In particular, the outlook for rates is extremely important in calculating how much you can afford to borrow and in deciding whether to opt for a variable rate mortgage or one where the rate is fixed.

This issue was raised forcefully last week when a sudden slump by the Australian dollar, mainly triggered by offshore events, prompted speculation that the Federal Government would be forced to lift rates to defend the currency. The same fear was raised by the balance of payments figures released on Monday.

A lift in rates would make it more attractive for overseas investors to hold funds in Australia with the resultant inflow of cash underpinning demand for the $A and so holding up its price (that is, the exchange rate).

In order to assist both prospective and existing home buyers to make an informed decision about their mortgages this report addresses two key issues:

* The likely size of rate increases over the next two to three years and;

* The range of mortgages home buyers can choose from, in particular, the special offers and the fixed-rate mortgages currently available. The main details of these are given in the accompanying tables, both on this page and on page 27.

Addressing the question of rate increases first, the key message from financial market economists is that, while rates on standard home loans are set to rise in 1993, the increase will be much less than the big lift which occurred three years ago.

This is the view of the five economists interviewed for this article: Grant Bailey, chief economist with Citibank; Bill Evans, chief economist with Westpac; Paul McCarthy, general manager in charge of economic research at the Commonwealth Bank; John Stroud, formerly chief economist with the Bank of New Zealand and now economic adviser to the Armstrong Jones funds management group; and Janet Tourney, senior economist with Macquarie Bank.

Overall, there is a remarkable unanimity among these economic experts, all of whom have extensive experience in analysing interest rate trends.

In particular, all argue that exchange rate concerns have stifled hopes of a further cut in rates and may mean that recent increases in both money market and bond rates are sustained.

Equally, however, they reject speculation that the Federal Government will be forced to engineer a significant lift in rates in order to defend the Australian dollar, arguing that the weakness of the current economic recovery makes such a move highly unlikely - at least before the next election.

"Events last week showed how vulnerable Australia is to offshore developments, but there was some very unrealistic knee jerk reaction to the dollar's fall," says the Commonwealth's Paul McCarthy.

"An attempt to defend the dollar by lifting rates is simply not realistic given the weak economy and the political situation.

"While a total, uncontrolled free fall by the $A would not be acceptable, the currency in fact needs to adjust to reflect the weakening of the price of the commodities we export."

All the economists interviewed say that, irrespective of what eventually happens in response to the current exchange rate uncertainty, short-term money market rates will rise in the year or so after the next election, in line with an expected economic recovery. They stress, however, that the increases are likely to be in the order of two or, at the outside, three percentage points.

This would equate to a ruling home loan rate of, at worst, 13 per cent, although probably no more than 12 per cent, by mid-1994.

But since any rise results in higher costs, all those surveyed lean, on balance, towards a strategy of borrowers fixing rates now.

"It is possible to lock in 9.5 to 10 per cent on a three-year fixed rate mortgage, which looks very attractive," says Macquarie Bank's Janet Tourney. "While the risk of a really big lift in rates over the next few years is extremely small, the certainty you get by fixing the rate at current levels is hard to pass up."

John Stroud of Armstrong Jones strongly agrees and stresses that the three-year rate is the best at the moment, both for the term and the rate on offer.

"With inflation likely to stay down it probably isn't wise to opt for a longer term. As well, the three-year rate is quite a bit lower than that on five-year mortgages," he says.

Bill Evans of Westpac, while acknowledging the benefits of fixing the rate, argues that, because the next upward trend in rates is likely to be relatively modest, the need to protect yourself from rate increases is not great.

"The low inflation rate should keep longer term rates down while short-term rates probably won't rise by more than two to three percentage points over the next few years," he says.

Grant Bailey of Citibank stresses that there is little risk of the Government pushing up short-term rates this year, due to the weakness of the economy and the demands of the next election. As well, low inflation will reduce upward pressure on longer-term rates.

On balance, while conceding that unexpected and dramatic international developments always can undermine interest rate predictions, none of the economists interviewed predicts a significant lift in rates in the next few years.

As a result, a strategy of fixing your rate, while broadly endorsed as sensible and timely, isn't seen as being vital in order to protect yourself against a crippling rate rise.

If prospective home buyers accept this analysis, the crucial decision becomes one of choosing between the mortgages on offer.

For those who haven't yet bought there is the option of using a standard variable rate loan (most have a rate of 10 per cent), making use of one of the special offers currently available or, where there is no special offer, taking out a fixed-rate loan where the rate is competitive since it is set for a relatively short period. These loans are covered in the table on this page.

The main reason not to make use of the loans covered in this table would be if you want to take advantage of the rates currently available on longer term, fixed-rate mortgages and so protect yourself against a rate rise over the next three years or so.

As shown by the table on the cheapest home loan offers, the best deal at present is the 6.95 per cent loan from the State Bank of NSW. This appears to be the case irrespective of the loan amount or the price of the property being bought.

This particular loan is capped, which means the rate can fall during the capped period but can't rise. It will fall if the rate on standard variable rate home loans falls below the capped level. In fact, given the current interest rate climate this is highly unlikely to happen. As well, for a fee of$250, you have the option of switching to a longer-term fixed rate loan at any time during the capped period.

When working out the upfront fees the examples in the table are based on a$100,000 loan taken out to buy a $150,000 property and a $160,000 loan on a$200,000 property. In most cases the fees shown have been rounded to the nearest $50.

In the case of the State Bank, since the loans to valuation ratio does not exceed 80 per cent, no mortgage insurance is required.

While this is true of many other lenders some require mortgage insurance on lower valuation ratios.

Such insurance is a once-off cost which, in the examples given, usually would cost between $600 and $750. If the loan is a fixed-rate interest-only mortgage, the insurance premium is higher.

The cost rises as the loan to valuation ratio (the ratio of the loan amount to the value of the property) increases.

Several lenders also have annual fees, although these are small (between$18 and $60 a year).

When deciding on which loan to use, however, it is not just a matter of looking at the rate and the other fees and charges.

It is also important to look at what happens at the end of the term.

It is useful to be able to automatically go, with little or not cost, to a standard variable rate mortgage repaid over 25 years.

The table on this page shows that Citibank does not offer this option.

It is also useful to have the option of fixing the rate, again for little or no cost. In this case the table shows that several lenders charge for this

Overall, anyone opting for a capped rate loan needs to remember that rates may have risen by the time the initial low interest rate period is over.

This means it is necessary to calculate how much you can afford to borrow using a slightly higher rate (say 12 per cent) in order not to be squeeze in a year or so's time.

The other option is instead to use a fixed-rate loan.

This is also an option for people with existing variable rate loans. If such borrowers fix the rate with their existing lender they usually get a substantial discount on upfront fees. Don't be afraid to negotiate about this and to take your business elsewhere if your current lender wants to charge a hefty fee.

As the table on this page shows, the rates being charged on three-year terms are much lower than for five years, with the lowest rate being 9.75 per cent charged by St George.

Before accepting a mortgage offer, however, check whether it gives you an absolute guarantee of continued finance at the end of the fixed term.

Usually this is in the form of a switch to a normal variable rate loan paid over 20 to 25 years or another fixed rate loan.

If the loan contract doesn't include the automatic right to such finance it would be better to opt for another lender.

The main concern with fixed rate loans is that the borrower will need (or want) to refinance during the fixed period. If this happens there is often a penalty. In most cases this is equal to what is known as the interest differential.

This is based on the remaining period of the loan, and the difference between the rate on your current fixed-rate loan and the ruling rate for that loan at the time it is paid out.

In fact, this system is quite good at a time when rates look like rising since if you need to repay it early and rates have risen you should get a credit in your favour. This is because the interest differential benefits you. However, few borrowers choose to repay a fixed rate loan in such circumstances.

The main risk of fixing is that the experts will get it wrong about rates and, instead of rising, they will fall further.

Still, if this happens anyone who fixs the rate now will have locked in a competitive rate and given themselves valuable protection against a sudden, large rate increase.

 HOME LOANS: CHEAPEST OFFERS
            Rate      Capped, fixed
 Lender      % p.a.    or variable
 Advance      7.9* *    Capped till 1-5-93
 ANZ          8.4       1 year fixed
 Bank of Melb 8.25      1 year fixed
 Bank of NZ   8.25      1 year fixed
 Barclays     8.35      1 year fixed
 Challenge    7.90* *   6 mths fixed
 Citibank     7.95      6 mths fixed
 C'wealth     7.95      6 mths capped
 Metway       8.25* *   1 year capped
 National     8.25* *   1 year fixed
 NatWest      8.95      1 year fixed
 State        6.95      1 year capped
 St George    7.95      Capped till 1-7-93
 Westpac      7.75      6 mths fixed
       Upfront costs*    Main options when Cost of
       $100,000 $160,000 term expires    options
 Advance   950    1400* * * Variable      None
 ANZ       550    1450      Variable      None
                            Fixed           "
 Bank Melb 850     850      Variable      None
                            Fixed    $250-$400
 Bank NZ  1400    1570* * * Variable      None
                            Fixed          "
 Barclays 1100    1100* * * Variable      None
 Challenge 500     500      Variable      None
                            Fixed      $500 min
 Citibank 1700    1900      Fixed         None
 C'Wealth  500     500      Variable      None
                            Fixed    $410-$550
 Metway    900    1350* * * Variable      None
                            Fixed    $250-$400
 National 400-600 400-600   Variable      None
 Natwest  1475    2100* * * Variable      None
                            Fixed          "
 State     600     600      Variable       $50
 St George 1200   1500* * * Variable      None
                            Fixed          "
 Westpac   600     600* * * Variable      None
                            Fixed          "
* Includes all costs incurred as a result of lenders' requirements (doesn't
include government charges such as mortgage stamp duty). $100,000 loan
assumes$150,000 house price; $160,000 loan assumes $200,000 house price. * *
Small annual fee applies. * * * Indicates mortgage insurance payable upfront.
 FIXED-RATE MORTGAGES
          Rate % p.a.    Upfront costs*
 Lender     3 yrs 5 yrs $100,000 $160,000
 Advance    10.5***11.0***  950    1400**
 ANZ        10.5   11.0     550    1450
 Bank Melb  9.95   10.5     850     850
 Bank of NZ 9.95   11.75   1400    1550* *
 Barclays  10.25   11.0    1100    1100* *
 Challenge 10.75*** n.a.    500     500
 Citibank  10.75   11.45   1700    1900
 C'wealth  10.25   11.0     820    1120
 Metway    10.5***  n.a.    900    1350* *
 MLC       10.5    11.0    1100    1100* *
 National  10.5*** 11.0*** 400-600 400-600
 NatWest   10.5    10.95   1450    1600* *
 State      9.95   10.95   1200    1500
 St George  9.75   11.0    1100    1500* *
 Westpac   10.75   11.25    600     600* *
            Early         Main options
          repayment        when term      Cost of
           penalty          expires       options
 Advance    3 mths int   Variable/Fixed None/None
 ANZ        1 mth int    Variable/Fixed None/None
        each year left
 Bank Melb  3-4 mths     New loan needed     $900
           interest
 Bank of NZ Interest     Variable/Fixed  None/None
         differential
 Barclays   1 mth int.   Variable/Fixed  None/$200
        each year left
 Challenge  2-3 mths     Variable/Fixed   None/
          interest                      $500 min.
 Citibank  3-4 mths      Fixed             None
           interest
 C'wealth  Int. diff     Variable/Fixed None/None
          + $300
 Metway    Int. diff     Variable/Fixed   None/
                                         $250-400
 MLC       Int. diff     Variable/Fixed  $350/None
 National  Interest diff Variable          None
 NatWest   Interest diff Variable/Fixed  None/None
 State     Int. diff     Variable/Fixed  $250/$250
           + $250
 St George 3 mths.       Variable/Fixed  None/None
          interest
 Westpac   Int. diff     Variable/Fixed  None/None
* Includes all costs incurred as a result of lenders' requirements (doesn't
include government charges such as mortgage stamp duty). $100,000 loan
assumes$150,000 house price; $160,000 loan assumes $200,0 house price. *
*Indicates mortgage insurance payable upfront. * * * Small annual charge. n.a. =
 not avaialable.

© 1992 Sydney Morning Herald

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