Will Your Home Rate Jump Through The Hoop?
The Age
Sunday July 10, 1994
Just what dangers does the changing interest rate environment hold for your home loan? Maureen Murrill asks the experts what they think.
LOOKING through the eyes of non-bankers, there are real traps for home buyers in the interest rate menagerie. If rates jump by 50 per cent in the next couple of years there is likely to be a considerable amount of ``wreckage" around.
The stockbroker Bain & Co. has lined up the standard home loan alongside what it thinks will happen to the domestic bill market. To keep the two in perspective, Bain says there are indications that by next June, home loan rates will be 11.75 per cent, increasing to 13.25 per cent in June 1996 and 13.75 per cent in March 1997.
The forecasting group BIS Shrapnel has an almost parallel view. By June next year it expects the standard variable housing loan to have risen from 8.75 per cent to nine per cent and to have increased to 13 per cent in 1995-96.
While BIS Shrapnel says it is a fairly strong hike in rates, it is not as dramatic as the increase in 1988-89 when interest rates hit 17 per cent. As well, it is unlikely to last as long. The company sees the rate dropping back to 9.5 per cent after 1996.
So, armed with this forecast and a carefully formulated view on the health of the housing industry - which is bullish on Melbourne and Sydney for the next two years - BIS Shrapnel can see merit in moving into a fixed mortgage for at least the next couple of years.
This is the view of customers and potential customers at the Bank of Melbourne. The bank's George Lawson says there is an increasing trend for people to want information about fixed-rate loans. While the bulk of the housing loan business on the bank's books is at variable rates, new business undoubtedly has a bias towards fixed loans.
Lawson says that while fixed rates extend out to five years, the one- year fixed loan that allows borrowers to make payments off the principal without penalty is proving extremely popular. The rate is 7.45 per cent for the first year, reverting to a variable rate which is currently 8.75 per cent.
While the Bank of Melbourne can pick up the trend, Susan McCarthy, ANZ's general manager for corporate affairs, says it is far too early to say whether the bank's customers have a preference for fixed-term mortgages, although she does acknowledge there have been more enquiries about fixed loans during the past few months.
At the IOOF Building Society, customers have been asking about fixed- rate mortgages, but the state manager, Rob Wood, said that last week, when IOOF said it would permanently undercut the Commonwealth Bank's variable mortgage rate by 0.5 per cent for five years, regardless of the Commonwealth's rate, branches reported that the enquiries had really started to flow in.
Wood says the difference in rates is certainly not eaten up by higher fees, and that if borrowers compare the ``0.5 per cent cheaper" offer figures at the end of five years with some of today's promoted fixed rates, there's a considerable saving on interest in favor of the IOOF loan.
Wood expects to write $20 million worth of business a month with this product.
Despite any number of reasons why interest rates should not rise, that have been offered by experts from the Treasurer down, the market is not listening. So why the contrary behavior? BIS Shrapnel says the main reason is a tightening of monetary policy in response to a deteriorating current account and in response to a likely rise in inflation - which the group expects could rise to about five per cent.
Bain, which has no banking connections in Australia, says some bank computer models show that someone earning $50,000 could borrow up to $225,000. When interest rates rise by 50 per cent, the bank's computers will lend only $150,000 in order to keep the servicing costs in check at 40 per cent of gross salary. But, asks Bain, what happens to the person with a $225,000 loan faced with mortgage repayments of $2500 a month earning $2900 after tax? Will the banks be able to keep a handle on the problem loans? There are some products, for instance, that could theoretically allow borrowers to capitalise their loan repayments, with all the inherent problems that suggests.
They could draw down an existing facility, not to pay for house improvements, but to meet the monthly mortgage payments.
However, banks are earnestly trying to create the impression that they are more responsible lenders now. Indeed, some say that no bank would really lend $225,000 to someone earning $50,000 unless there were other assets.
Bain's thesis is that the general public tends to be motivated by the highest advertised deposit rate and the lowest borrowing rate, often ignoring the term of the contract. It also says that the large number of fixed-rate products now available has effectively changed the rules of the game. If the variable rate moves above the fixed rate, all customers will be motivated to refinance into fixed-rate loans.
Bain says that based on its interest-rate outlook, a current fixed- rate loan at 8.75 per cent could save a variable-rate customer up to $7000 for each $100,000 borrowed during the next three years.
Bain also has an opinion about the bells and whistles being offered to what it calls ``hapless home-owning customers" in the form of offers to consolidate debts and unlock the equity in their houses for any worthwhile purpose. Bain says the bait is a low 8.75 per cent variable rate.
At times like this, Bain says, non-home owners should be grateful their ``have-not" status means the banks have passed them by.
``The major risk from this type of lending is that years of savings discipline in a regulated, vanilla product environment can be undone in a moment of rash spending by the customer."
Bain says that extending housing credit is not a cause for immediate alarm, given Australia's good debt-servicing record and relatively low debt burden. But at the same time it says there are signs that the seeds are being sown for a house price boom, which needs only mild promotion to get out of hand.
The brokers say there are ways to take the heat out of the housing market, such as regulating an upper limit on finance to 75 per cent of the value of the property and insisting on mortgage insurance for new customers. They say that this has been used with great success in Germany and Hong Kong.
The authorities could also introduce a change to the risk weighting of housing from the concessional 50 per cent of assets. However, this is not considered likely as it would put Australia out of step with international practices and it would not rest easily with the Reserve Bank's move last year to relax the definition of capital adequacy as far as house lending was concerned.
Another option would be to the remove negative gearing on investment property or a rapid increase in interest rates.
Bain says the Reserve Bank will continue to alert both banks and their customers to the risks they might be running and that ultimately this may lead to heavy use of monetary policy to slow the housing sector in the absence of introducing other measures.
It is interesting, they say, to muse that should the baby-boom generation overcommit on housing debt while driving prices to unaffordable levels for the next generation, the Government might consider a bale-out of the favored constituency with mortgage interest rate tax-deductibility, which applies in the United States.
© 1994 The Age