Fixed rate home loans are at their lowest ever — but they come with a catch
Interest rates in Australia have plumbed new depths since the Reserve Bank’s monetary policy announcement on Melbourne Cup Day,
It’s taken several weeks, but following a number of extraordinary policy measures by the RBA (including a formal adoption of Quantitative Easing), at least one bank has taken the decision to offer a three-year fixed home loan rate of 1.89 per cent.
That’s low. In fact, according to interest rate comparison site, Mozo, it’s the lowest commercial fixed interest rate (with an 80 per cent Loan to Value Ratio or LVR) the country has ever seen.
Fixed rates are dropping to all-time lows because the banks are desperate for your money. So far the evidence shows they’re getting it.
The ANZ bank reports borrowers “flocking” to take out a fixed rate loan.
But who really benefits from ultra-low fixed loan rates? The answer lies in finding a solution to the one big unresolved problem COVID-19 has produced: on-going uncertainty for business.
Lowest fixed rates in history
This year has seen many aspects of business and finance turn upside down.
And this year, not only have fixed rates fallen below variable rates, but the interest rate gap between them has never been wider, according to the ANZ.
Based on the ANZ Bank’s estimates, the average three-year fixed rate has nearly halved over the past two years, from 4.1 per cent in late 2018 to around 2.1 per cent currently.
Borrowers, especially first home buyers, are taking advantage of this once-in-a-generation phenomenon.
Inner west Sydney mortgage broker Bruce Carr says business dropped off soon after the coronavirus pandemic struck, but in recent weeks, thanks to the Reserve Bank’s extraordinary policy measures, it is picked up quite dramatically.
“Definitely, there’s been a much higher demand for fixed rate loans, and people are tending to fix for shorter periods,” he says.
It’s Carr’s job to keep an eagle eye on interest rate movements and he says variable rates have barely budged in recent weeks.
“Through the last two RBA cash rate reductions, the major banks in general have not moved their variable rates down at all — there have been a couple of exceptions here and there — but they have moved their fixed rates down sharply.”
There are two forces are at play here.
First, the Reserve Bank is using its policy fire power to lower the cost of borrowing for the banks, which means they can offer cheaper products.
And second, the banks are frightened.
They’re scared of losing customers as the economy struggles to gain traction, and they’re anxious about losing business to their competitors.
For the banks, in these highly uncertain economic times, locking in customers has been given priority.
“I’d say I haven’t really seen anything like this [in my 22-year career]”, Bruce Carr says.
How did we get here?
The cash rate is traditionally seen as the benchmark rate that influences lots of different interest rates, including loan products with the big banks.
The Reserve Bank sets the cash rate target, not the actual cash rate. It is determined by the money market.
When the Reserve Bank lowered its cash rate target to 0.10 per cent on Melbourne Cup Day, the money markets moved swiftly.
The rate has since been bouncing between 0.04 and 0.05 per cent. Ever so close to zero.
Meanwhile, in the background, the Reserve Bank has been doing its best to lower interest rates “along the curve” — that is, trying to lower both short-term and long-term interest rates (which affect both variable and fixed rate loans respectively).
It’s also indicated it won’t entertain the idea of raising the cash rate target until it’s seen a big improvement in the unemployment rate — which is understood to be at least three years away.
This policy environment has convinced banks they can comfortably slash the interest rates on their fixed loan products.
Property market expected to soar
As you might expect, the demand for fixed rate loans is filtering through into the property market.
As the ANZ’s Housing: a strong 2021 report notes “the housing sector is turning a corner”.
“After falling since April, national house prices were flat in October and look set to rise over coming months.
“We now expect house prices at the national level to rise modestly over the balance of this year.
“Next year, we expect price gains of around 9 per across the capital cities.”
When you enter into a contract with a major bank, make no mistake, it expects to benefit from it.
You, on the other hand, may not.
A lot can happen in three years. The bushfires and coronavirus have shown a lot can happen in the space of just three months.
If you lose your job, sell your home, or are hit with significant ongoing unexpected expenses, a fixed rate loan can turn into a nightmare.
If you have to end the contract, you’ll be charged a break fee based on how much you owe and how long was left on the fixed term.
The Australian Securities and Investments Commission’s Moneysmart website notes, “the break fee may be very high”.
“Generally, the more interest rates have come down since you took on the fixed rate loan, the higher the break fee will be.”
The banks want to lock you in as a customer now for as long as they can, and it’s creating some extraordinary opportunities for borrowers, but don’t be fooled into thinking you can’t lose.
As Bruce Carr says, “in volatile economic times, it’s not always good sense to lock things up.”