A Matter Of Interest

The Age

Sunday June 18, 1995

Lisa Pickersgill

Lisa Pickersgill explains how variable rate home loans have saved borrowers more than $10,000 in five years.

BORROWERS taking advantage of the regular shuffle of variable rates 15 movements since mid-1990 are clear winners beside those confined to a fixed rate at the wrong time. From June 1990 to June 1995, those who borrowed $100,000 on a fixed-rate loan dished out $10,180 more interest than an equivalent variable-rate home loan borrower.

In mid-1990, both three-year fixed and variable rates were positioned at 16 per cent, according to the Bank of Melbourne. By the end of the first year, variable rates had slid smugly to 13.95 per cent. In June 1992, variables were 10.95 per cent. Anyone who had immunised themselves from rate movements in a three-year fixed rate of 16 per cent in June 1990 suffered severely.

Assuming that in June 1993, the fixed-rate borrower switched to a two-year fixed rate of 9 per cent, the total interest paid over five years would have been $65,280. On the three-year 16 per cent fixed rate, interest paid was $47,750 and interest totalled $17,530 over the two-year 9 per cent fixed loan.

During the last two years, variables moved from 10 per cent to 8.75 per cent. Over five years, the variable rate borrower would have only paid $55,100 much less interest than the fixed-rate option. The clear message is, do not lock into a fixed rate near the peak of the cycle even if you think rates are likely to soar higher.

The level of interest is not the sole factor to be considered when borrowing money. For those who need or prefer a steady repayment schedule, a fixed-rate loan may be the only choice. But history shows that the majority of borrowers opt to ride with variable rates to take advantage of the low peaks in the cycle.

But as Alastair Hunter, banking analyst at J B Were, says ``while fixed-rate lending represents only approximately 20 per cent of total mortgage outstandings, they can represent a significant percentage of lending in a given year". For example, 80 per cent of new housing loans approved in 1993/94 were 12-month capped loans, he says.

Selecting a home loan is a calculated gamble. Money lenders have recently mustered enthusiasm among potential borrowers by cutting fixed rates. Now well below variable rates, these rates could be a bargain difficult to refuse. Twelve months ago, variable rates may have seemed the logical choice. In hindsight, there are always losers.

Craig James, senior economist at State Bank NSW, says it is a line- ball decision for borrowers who want to decide between a fixed or variable.

``The magnitude of any movements will depend on the strength of economic growth and the inflationary cycles," he says.

Variable rate borrowers need to be open to the possibility of a slight uphill ride followed by potential benefits in the longer term, he says.

Chief economist at Armstrong Jones, John Stroud, says potential home-loan borrowers must consider their own risk/return balance.

If a borrower believes there is a significant chance rates will begin to rise after the economy reheats, it may be better to lock into a fixed rate now, he says. If you choose to fix, you are not likely to be caught by any variable rate rebound, he says.

Securing a fixed rate must be weighed up with the costs involved.

After one fixed term expires, many financial institutions (see accompanying table) charge a fee to move to another fixed home loan.

For example, the Bank of Melbourne charges $250.00 to switch to a new fixed rate. Most do not charge borrowers to move from an expired fixed loan to a variable rate.

You will also have to pay a penalty if opting out of the fixed-rate loan during the term. For example, the Commonwealth Bank charges $300 plus an interest rate adjustment. The adjustment is based on what the bank could re-lend or re-invest the amount repaid by borrowers.

Depending on the interest rates when you opt out, it could mean you will need to pay the bank, or vice versa. If the rates calculated for the remainder of the fixed term is less than the rate when you applied for the loan, you must pay the bank.

For example, say you signed up for a five-year rate of 9.5 per cent and want to jump after three years. If the current rate on the remaining two years is 7 per cent, you will pay the bank $443.00 for every $10,000 remaining on the loan.

Alternatively, if the fixed rate when you decide to opt out with two years remaining is 12 per cent, the bank will owe you $422.00 for every $10,000 remaining.

Wayne Dent, senior manager of mortgage administration at Bank of Melbourne, says people typically incur these penalties when they sell their house and need to get out of the loan. Or they decide the interest rate they have locked into is too high considering what else is on offer, he says.

Split home loans can give borrowers the best of both worlds by allowing access to both variable and fixed rates. For example, the St George Bank ``Fixed and Free" loan means borrowers can make extra repayments against the variable portion and benefit from the security of a fixed rate for the remaining part of the loan.

Obviously the movements of both loan rates can strongly influence a borrower's level of repayments. Home loan rates are priced on rates the lender can access from the money market. Fixed rates are ultimately priced on government bond yields and variables are connected to short-term 90-day bank bill rates.

Last week, Bernie Fraser, governor of the Reserve Bank, indicated that he had not ruled out a further rise in official cash rates.

If this occurs, it would flow through to bill rates and, depending on the competitive heat felt by lenders, could lift home loan variable rates. Alternatively some lenders could choose to absorb this extra funding cost and not lift variables.

Recently some lenders, such as Citibank, Westpac and Aussie Home Loans, did lower variable rates. Moving its standard variable rate from 10.75 per cent to 10.4 per cent, Westpac now compares favorably with other lenders' variable rates which hover around 10.5 per cent.

Mortgage originators are maintaining competitive pressure with an average variable rate of 9.67 per cent.

Broadly however, lenders have declined to please the crowd with an encore of variable rate cuts. The risk is that the interest-rate cycle has not run its full term. NSW State Bank's James says ``as financial institutions cannot change home loan rates every week, most are sitting tight on their variable rates until they are sure where rates are headed".

James says ``the Reserve Bank wants to have at least 0.5 per cent up it's sleeve to manage any further economic growth".

He believes the Australian economy has paused, rather than slowed down. Similarly Paul Dortkamp, head of asset allocation/risk management at First State fund managers, says a few weeks ago the economy was slowing down; now that has come to an abrupt end.

Stroud says short-term rates, which influence variable rates, are sitting on an extended plateau.

``The cash rate is likely to be put on hold for the next three months, although based on current data, there may be an increase in official cash rates by late 1995 or early 1996," says James.

On the other hand, fixed-rate loans are priced on swap rates which are tied to government bond yields, says James.

``The falls in US bond rates have been replicated here. There has been a one per cent drop in 10-year government bond yields since the late April peak of 9.85 per cent. ``This has reduced the cost of funding for lenders and led to the cuts in fixed rates.

     SWITCHING COSTS.
     For existing home loans.
     INSTITUTION          VARIABLE TO       FIXED TO
                       FIXED RATE         FIXED
     Adelaide Bank           Nil                Nil
     Advance Bank        Est fee & EDI        Est fee
     ANZ                     $300               $300
     BankSA                  $200               $200
     Bank of Melbourne       $250               $250
     Bank of Queensland      $300               $300
     BNZ                     Nil                Nil
     Challenge               $500               $500
     Citibank                Nil                Nil
     Commonwealth            $300               Nil
     Metway              0.75 per cent     0.75 per cent
     National                $600               Nil
     St George Bank          $500               Nil
     State Bank NSW          $250               $75
     Town & Country          Nil                Nil
     Trust Bank              $325               $325
     Westpac            $200/0.25 per cent      Nil
     Source: CANNEX.

© 1995 The Age

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