What’s happening to Interest Rates? 

The most common questions that I am getting at the moment is “Should I fix my loans?”

 The newspapers have been telling us that banks are putting up interest rates and the government have bashed the CBA for their 0.1% increase to their variable rate. (Which by the way, is still slightly below most of their competitors).

 It’s a fact variable interest rates are at historical lows and so there is only one way they will go in the medium term, although there is some debate as to when and if they will substantially move upwards.

 So what is actually happening and why?

 Medium and long term rates have been going up now for several months. You may remember our April newsletter suggesting that then was the time to fix if you were going to.

 Now, you need to do the sums carefully. Especially as fixed home loans are just another product for sale and when demand is high, the price rises.

 We could get into the technical reasons for the interest rate rises like the Australian governments new massive debt that needs to be funded from the markets or the forecast that we will have inflation due to the recovery and other technical factors, but that won’t help you decide if you should fix or not. 

Fixing your home loans is like buying an insurance policy, a “sleep easy” product to give you piece of mind.  You are insuring that your payment stays the same for a specific period of time. Like all insurance there are costs associated with them and restrictions. 

Think about the impact of fixing and also the consequences if you don’t.

 Again using the insurance analogy, if you are on a tight budget and will lose the home if rates go to say 8 % then it probably could be prudent to get insurance and fix some or all of your loans at or bellow that rate. Remember also though that fixed rates have restrictions on how much extra you can pay and can have large break costs if rates go down.

 No one knows where interest rates will go. The banks and other lenders try to pick the market and need to ensure that they get a return. Think about how you might invest any extra money. If you can get the money instantly through an ATM then you would probably expect less return (interest) than if you lock the money away for a longer term, say on term deposit for 3 years.

 As a rule, the longer the money is “locked”, either deposits or loans the higher the return (interest rate) needs to be. This is to pay for the opportunity cost of not being able to use the money elsewhere, to make an allowance for the unknown future and any potential rate moves.

 Let’s look at a Home Loan example. If you are currently paying around 5.2% (The rate most Australian home loans are at the moment even though the standard variable average is around 5.74%), and you now fix what will it cost?

 Current 3 years fixed rates are between 6.6% and 7.0 %. If you were to fix longer then the rate would be mid 7%’s for 5 years and higher for  longer.

 Again what does this mean?

If you fix now at say 7% for 3 years, then interest rates need to go up nearly 2 % almost immediately, go up 3% within 18 months or 4% in the first two years of the loan for you to “win”.

 If variable interest rates were to stay the same, then obviously you would lose.

 Below I will outline where the wholesale market thinks rates will be in the next 5 to 10 years, but again there are no certainties. All the traders are like me and stare into crystal balls that don’t have instruction manuals!

 I have taken the rates that the wholesale market has set from the Australian Financial Review – “Money & Bond Markets” 15^th June 2009 reflecting the closing prices Friday 12^th. *

 *Please note that the wholesale market changes daily and there is also a risk and a time premium in the rates.

 What this could show is that the wholesale market expects rates to go up less than 2.55% in the next ten years. (They need to make allowance for the time / risk in the rates). This could change in an instant though as the World and Australian economies change. Home loan rates are also not directly funded or set by these rates, but all rates in the market are related in some way to each other.

 Please do not take this as advice on your personal situation and whether it is best for you to fix part or all of your loans. Your individual goals and objectives are simply that, yours.

 Fixing rates depends not only on the rates in the market, but also has to do with how long you plan to hold a property, your disposable income, job security, your future financing needs and overall goals. All I ask is that you do the sums.

 However, I suggest that you take the time to contact your Origin Finance Client Advisor to look at your situation and see what you can do to streamline your home and investment loans. See if you situation warrants fixing part or all of your debt.

CEO

Origin Finance

North Sydney Office

1300 306 767