So far 2017 has proven to be a turbulent ride for home loan interest rates and all the signals are pointing towards higher rates on the horizon.
So why are rates starting to increase and what can you do to ensure your lending remains in line with your life? Jason Dunn, General Manager, Strategy & Distribution takes us through the detail.
Rate increases are dependent on a range of factors
At a macro level, home loans are subject to the same market forces as many other commodities. Competition between lenders, deposits and bank rules also play a huge part in how mortgage rates move, as well as Global bond rates, the Reserve Bank of Australia (RBA), monetary policy and volatility in markets.
The way your mortgage is structured and the type of loan you have also plays a large part. You may have a variable loan rate, which can move in line with a lenders parameters – up or down. The type of loan can also have an impact – if the purpose of the borrowing is for an investment, this can incur a higher interest rate which may reflect the overall risk level the lender feels is appropriate given the risk it may be exposed to.
Let’s examine some areas in more detail.
Banks generally obtain their funding globally. They spread the risks over the long-term, but these rates can move – especially when there is an increased level of market volatility or uncertainty. There’s more to this – including credit spreads (a difference in yield between two different bonds) which can help to reduce sudden spikes and soften the impacts, but the reality is banks need to refinance portions of their book regularly and this can lead to increased rates which are basically driven by increased funding costs.
Saving deposits play a huge part in funding for banks – about 60% of their books. Although this seems high, many other nations have levels which match or exceed their lending. In this case Australian banks generally turn to the wholesale market to cover any shortfall in lending needs. This and any increase in deposit rates can impact a banks funding costs which are generally passed on.
However, saving deposits aren’t really rising to any great degree. New rules require the banks to maintain a “stable funding ratio” (a banking reform which is designed to promote a more resilient banking sector) which sets a priority on retail deposits. This can impact the way a bank lends, as they are required to raise deposits to fund for any lending. In reality this may impact lending rates as banks increase the interest rates to attract more deposits.
Banks are under pressure
Banks are becoming increasingly pressured to generate high returns, largely driven by shareholders who expect good returns on investment. There is also additional pressure through increased regulatory requirements to shore up balance sheets to counteract any market changes – a bit like the Global Financial Crisis (GFC) experienced in 2008, and the rising costs of operations and funding costs. The take away here is that this has placed increased pressure on banks to maintain and increase profits which in turn has led to these costs being passed on.
The type of loan that you take out can impact the cost of borrowing. Investor loans are slowly increasing in cost, mainly due to the regulators’ concerns about the continued ferocity of investment loan growth. This can be reflected in the investment market being a more volatile environment – as an investor who is under financial stress is more likely to offload an investment than an owner occupied home – maybe at a discount which could impact the ability to repay the loan. The regulator imposed various limits on investment loans which has driven the price of these loans up.
Owner occupied loans, designed for the home you own and live in, have had less restrictions imposed, which has rendered this area of the market more desirable and therefore still quite competitive. Whether you have a variable or fixed rate loan will obviously impact on the cost of borrowing too – simply put, this is usually a reflection of the banks wholesale funding costs – if they go up, so does the cost of your mortgage.
Competition – the more the merrier
It’s hard to imagine a more competitive loan environment – even though we’ve seen some interest rate increases recently. Competition certainly has played a part in helping to drive an increased level of competitive behaviour from banks and smaller lenders who have been keen to grow market share. Many new and smaller players, have been using very attractive rates to entice borrowers onto their books. Home loan brokers have also had a part to play as they scour the market for competitively priced home loans that reflect the borrower’s needs.
It could be argued that banks have been discounting to attract borrowers and this won’t continue for the long-term as they begin to fulfil their funding mixes of owner occupied and investment loans and lending to deposit ratios.
The Reserve Bank of Australia’s official cash rate has been left at a consistent 1.5% from August 2016, is enabling lenders to pass on highly competitive rates to borrowers. As the lucrative home loan market continues to grow as the population increases, it’s likely that competition is only going to remain strong and get stronger.
So what does 2017 have in store?
It’s hard to deny that the regulator’s desire to slow investment lending hasn’t impacted the home loan market. Slowly but surely banks are taking measures to balance their books and encourage deposits (usually by developing higher interest returning products) to shore up their balance sheets.
The recent scrutiny on the banking industry also looks like it’s impacted some banks’ policies as they increase their deposit rates and desire for capital. Sure, there is increased competition in the market which is keeping lenders competitive, but the impact of the regulator’s desire to slow the fast growing investment lending market seems to be taking hold. Some banks are placing increased restrictions on lending or reducing their appetite for investment lending overall. What this is starting to indicate is that rates will increase, maybe not severely, but its likely 2017 will be a more expensive year for borrowers than we’ve seen in 2016. What this means for borrowers is simple – if you haven’t reviewed your lending in the past 12 months, it’s worth doing it now.
General Advice Disclaimer
The information contained in this article is general in nature and does not constitute personal financial advice. It has been prepared without taking into consideration your personal objectives, financial situations and needs. Before acting on any information contained in this article you should consider the appropriateness of the information having regard to your objectives, financial situations and needs.