Right now banks are going crazy advertising fantastically low interest rates on home loans. This comes as the boss of ANZ says rates might have to rise earlier than expected to avoid an escalation of social problems.
And home loan expert, Mark Bouris, in a one-on-one interview with me on my Switzer TV Property programme last night gave some timely warnings about fixed rate home loans, recommending borrowers have a close look at not just the advertised rates of their new loan but also the comparison rate!
This comes as ANZ’s CEO Shayne Elliott admits that the loan-to-income ratio, which tells you how we Aussies can service our loans, is very low. This means we could cope with interest rate rises to a certain degree, but he says the pace of house price growth is starting to “raise eyebrows” in places that count (banks, the Reserve Bank, APRA etc) for interest rates.
That said, the RBA Governor Phil Lowe is sticking with his story that rates won’t be rising at least until 2023 and maybe 2024. And senior economists like Westpac’s Bill Evans and AMP Capital’s Shane Oliver (who the media are always quoting) aren’t disagreeing with Dr Phil.
As The Australian’s Lachlan Moffet Gray points out today “on Tuesday RBA Governor Philip Lowe reaffirmed his belief that inflation will not be sufficiently high enough to justify an increase to the 0.1 per cent cash rate until ‘2024 at the earliest’.”
I think he believes the housing boom can be slowed down by APRA telling lenders to play tightwad with loans, like they did in 2016. This killed off the house price surge and sent home values down in 2017 and 2018. But that trick won’t slow down the overall boom that I suspect will take hold of the overall economy.
The ANZ boss didn’t explain how he thought social problems could come out of these house price rises but they could easily come about because people are paying too much and borrowing too much to buy a home and then seeing that Dr Phil was wrong on interest rates, which rise earlier than expected.
Dr Phil could be wrong. If he is wrong, he’ll have to raise rates. And for social or economic problems for individuals in debt to occur, there’d need to be quite a number of rate rises for issues to become serious. If borrowers or would-be borrowers are worried about rates rising too high, they’d be well advised to take some Mark Bouris lessons from what I’m calling Home Loans 101.
My interview with Mark focused on these unbelievably low fixed rate home loans, these huge cashback offers from lenders (which he says doesn’t happen anywhere else in the world), and how borrowers have to look at the comparison rate of interest and not just the advertised rate.
So this is what Mark taught me:
1. Generally, a fixed rate home loan will mean you can’t pay off your loan more quickly if you have a windfall. Some lenders will allow a limited amount of extra repayments on fixed rate loans these days, but most won’t allow you to redraw those funds.
2. If you want to get out of a fixed rate home loan, there’ll be break costs. And if you’re considering selling/upgrading your home in the short to medium term, avoid a fixed rate.
3. A cocktail loan, where you fix only part of your loan and leave the balance on a variable rate, can be a better option as it means you can reduce the variable loan part of the loan. Also, if rates rise and you have a half-fixed and half-variable loan, then each rate rise will be halved.
4. The comparison rate provides you with insights into the long-term cost of your loan, including after the fixed rate period has expired.
5. Comparison rates are calculations that take into account all the ascertainable costs of the loan, including ascertainable fees (set up, discharge and ongoing) and the interest rate on the loan. The comparison rate looks at the variable rate a borrower goes onto after the fixed term ends, and the interest rates you’ll pay when the fixed term ends. Mark says 90% of borrowers just go onto the variable rate loan that their bank puts them into after the fixed term expires and they are often on very high rates.
6. With a variable rate loan, if the comparison rate is similar to the headline rate, then there are less fees to worry about and vice versa. From the ANZ website, their variable rate Break Fee package loan has a variable rate of 3.49%, while the comparison rate is 3.91%. The cause of the difference here is the annual package fee of $395, which becomes a proportionally larger cost over time as the loan pays down.
7. Honeymoons don’t last forever. This example using the Westpac Flexi First Intro Offer, where the Headline variable rate is 2.29%, shows that. The comparison rate for this loan is 2.72%. This difference is not driven by an annual package fee, it’s more a function that the loan is heavily discounted for the first two years and the discount is reduced by 0.5% thereafter. So the rate reverts to 2.79% in this example. That said, Mark says the interest rate structure on the ANZ website is reasonably well disclosed.
8. Looking at the comparison rate and fixed rate home loans, Mark pointed to a CBA product, which is a 4- year fixed rate under their Wealth Package at a quoted rate of 1.99%, whereas the comparison rate is 3.66%. So having such a large difference would mean that you need to do a lot of investigating of where the difference is being driven from. In this case, the differences are driven primarily by:
In short, if there is a large difference between the headline rate and the comparison rate, it should be a flag to investigate further so an individual can determine what’s going to provide them with the best long-term value.
9. On cashback offers, I asked Mark how good they are.
He said that they’re “great for the economy when it needs spending because of the Coronavirus but what about the borrower over time?”
10. “Teamed up with fixed rate loans, these cashbacks have the potential to offer quite substantial short term benefits but at a long term cost,” he said. The table I’ve included below illustrates this point, with life of loan costs varying by upwards of $80,000 between a simple variable rate offer and the fixed rate headline from the same bank.
10. A variable loan at 2.69% with a $4,000 cash back sounds compelling when compared to a variable rate of 2.39% with no cash back. However, this table that illustrates the cumulative interest paid over various terms during the loan, shows it doesn’t take long for the benefit of the cash back to be eroded.
Comparison of two $500,000 P&I home loans set up over a period of 30 years
11. “As you can see, a consumer that is prepared to refinance their home loan every 2 years may benefit from the cash back,” Mark points out. “However, the question remains what is in the borrower’s best interests, refinancing every two years impact on their credit file and also presents another problem of re-setting of loan terms…”
12. He also argued that more often than not (unless borrowers are more mature in years), when a refinance takes place, the loan term is re-set generally to a 30-year term. “This can provide the illusion of savings off monthly repayments, but as we all know it can end up costing the borrower more in the long run,” he said.
On a like-for-like basis, a cash back is an obvious benefit. However the issue is when the upfront cash incentive encourages a customer into a product that may not offer good long-term value.
The clear lessons are that you have to look at the comparison rate on any loan you take out and understand where it might leave you in two, three or four years’ time. In fact, being on top of your loan and always looking for the best deals makes a lot of sense.
Also, if you take a cashback offer, you better be a regular loan switcher, but it could affect your credit file rating down the track. And if you’re a borrower who has ignored the comparison rate and you just let the loan set-and-forget, you could lose a lot of money over time.
One point Mark made that should make you keep your eyes open is that banks are not in the charity business. These low fixed rates could be great for you if it means you’re paying out less per month when you might have cashflow problems, but the banks are copping short-term reduced profits on these loans so they can have you for a long time.
And they’re not doing this because they love to hang out with you for social purposes. You are a potential profit centre, so make sure they don’t make too much money out of you!
And as I always argue: “Anything worth doing is worth doing for money!”
By the way, I asked Mark what his YBR best variable home loan rate was and he said it’s at 2.39%, or 2.42% on a comparison rate basis. He also said there are some online loans out there that are cheaper. But for non-online loans, that should be a good number to have in your head if you go shopping for the best deal possible.
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