October – 2009
The Aussie economy is killing the rest of the world. While every other developed country has been in recession, we’ve avoided it and now are the envy of the world. But that gloating comes at a price and the price is higher interest rates.
As Reserve Bank governor Glenn Stevens recently said we’re out of the emergency rates period and that means rates are on the rise.
In fact Stevens talked about rates going “towards more normal settings”.
Saul Eslake, program director –productivity growth at the Grattan Institute says this statement does not necessarily mean that we will see rates up at what was deemed average before the global financial crisis.
Firstly Eslake point out that Stevens uses the word “towards” rather than “to” which would imply the Reserve Bank governor does not intend to push rates to the more normal settings which have been between 5 and 6 per cent on average over the past 17 years but rather towards them.
And Eslake also makes the point that before the global financial crisis, the spread between the official rate and what lenders charged mortgagees was about 180 basis points. Since the GFC, the spread has jumped to about 280 basis points. That is when the base rate hit a low of 3 per cent, the average variable home loan rate was about 5.80 per cent. When official rates peaked last year at 7.25 per cent, this commanded an average mortgage rate of about 9.05 per cent.
“So unless spreads were to come in which appears unlikely then neutral monetary policy would have normal settings at between 4 and 5 per cent,” says Eslake.
As a result he believes that interest rates will be between 4 and 4.5 per cent by October 2010 rather than above 5 per cent and that the hike of around 1 per cent will be over a period of time.
“I think there will quite possibly be one more rise before Christmas,” he says. “And then subsequent rises next year.”
But even with these rises, they will be gradual and a 1 per cent increase on a $300,000 loan would only be equal to extra payments of $185.66 a month maybe one year down the track, according to Canstar Cannex. This calculation is based on an average home loan rate of 5.775 per cent which is what prevailed before rates started their upward move earlier this month.
Either way you wouldn’t be hit with the $185.66 in one fell swoop.
At the Reserve Bank meeting in October rates were lifted 25 basis points increase in October from the historic low of 3 per cent to 3.25 per cent and most lenders increasing their variable rate accordingly.
For many established home buyers, the latest 0.25 per cent rise will be easy to manage. Indeed it appears that a large number of those with existing mortgages have continued the higher repayments since rates started their downward spiral and as a result have sufficient equity in their homes to ride any storm.
But the group that may feel pressure are the first home owners who have only recently jumped into the market to take advantage of the bonus grant.
According to Mitchell Watson of Canstar Cannex one thing first home owners might consider in order to alleviate the situation is to switch from a standard variable home loan to a basic variable one. The difference between the two variable rates is about 0.7 per cent and so if you have a large mortgage, it might make a reasonable impact.
Watson’s argument is that given you have just entered the market, you have no equity in your mortgage account to redraw yet, so what’s the point in paying for that option?
Of course there may be break costs associated with switching loans, but at least do your homework and find out how you stand. Short-term pain may translate to long-term gain.
Anybody considering a fixed home loan in light of the upward move in interest rates, however, should think again. Fixed rates are substantially higher than variable rates (currently an average 7.19 per cent for a three year fixed) so you may conceivably end up paying more than a variable throughout the term of the loan. Certainty of payments may be assured but you’ll be paying a hefty price for it.
Matthew Bell of Australian Property Monitors says mortgage rates would have to double to 10 or 11 per cent for you to benefit from a fixed rate loan right now.
The simplest solution is to always try to pay more than the minimum amount so you can eat into your principal and then when a rate rise comes you will be able to meet your higher repayments with ease.