Fixed rate fix

Yesterday, a customer contacted me about a letter they received from their bank. It was an offer to move from their current variable rate home loan to a fixed rate “to avoid the uncertainty of rising interest rates”

Ordinarily there would be nothing wrong with this. Banks often try to retain customers by getting them to fix their rate for a number of years and in some circumstances this can be advantageous to both the bank and the customer. However, this letter was sent only a few days ago when so much of the current media is devoted to the extreme likelihood of interest rate reductions.

Most of the major banks have already announced substantial reductions to their 2,3 and 5 year fixed rates. They have also begun to reduce their interest rates on a number of deposit products. This is an important signpost for the direction of interest rates for variable mortgages.

After 12 rate rises over the past several years, we may be headed for a period of interest rate reductions. To advertise to a customer to move to a fixed rate “to avoid the uncertainty of rising interest rates” at this time is just a bit shallow, particularly if a series of rate reductions by the Reserve Bank result in a further reduction in short term fixed mortgage rates.

Even the bookies think rates will drop

From today, Australian betting agency, Centrebet will be taking wagers from punters on changes to the Reserve Bank’s official cash rate, with the initial odds favouring a drop in rates when the bank meets next Tuesday.

Centrebet is paying $1.25 for a rate cut of one quarter of a per cent and $3.50 for a cut of more than a that.

If you place a bet for rates to stay the same, and you’re right, the bookmaker will pay you $5 and if you back an increase of one quarter per cent – a scenario considered highly unlikely – you’ll get $51.00

For a rate rise of more than a quarter per cent, Centrebet is paying $201.00!

A spokesman for Centrebet predicted the book would be popular because of the high level of interest in rate movements.

I’m not placing a bet, I’ll save that for the Melbourne Cup. But if you want my tip – go for the favourite - a quarter per cent reduction.

(Source: The Australian, 27 August 2008)

All prices quoted are AUD

NAB's rate cut pledge

Good news for home owners with a mortgage! National Australia Bank (NAB) has gone public with a promise that if the Reserve Bank of Australia (RBA) cuts rates by 25 basis points in September, NAB will pass that reduction on to customers. NAB chief executive Ahmed Fahour said that a recent easing in short-term funding costs had enabled NAB to make the commitment to reduce its standard variable rate. "While we continue to see volatility in international markets and increases in the average cost of long-term funding, we have experienced some short-term funding relief, which we are keen to pass on to our customers," Mr Fahour said.

While other banks have been reluctant to make any similar commitment, they will now be under considerable pressure to do likewise. Analysts believe they will fall into line with NAB when the Reserve makes its rate announcement. ANZ indicated last night it was likely to pass on the full benefit of any official cut by the RBA to home borrowers. "If the current funding environment remains as it is, and the RBA cuts, the likelihood is we'll be passing on the benefit to home borrowers," said ANZ's Paul Edwards.

While this is encouraging news, what happens if the RBA cuts by 50 points? NAB has only given an undertaking to pass on the full rate cut in the event of a 25 point reduction.

I think it is highly likely that as rates continue to fall over the next several months, the major banks will take some opportunity to increase their lending margins by not passing on a full RBA rate cut or two at some stage in the easing cycle. What do you think?

(references: Herald Sun, 22 August 2008; National Business Review, 22 August 2008)

Make low-interest-rate cards work for you

You can look at credit cards in all sorts of ways but typically they all fall into two major categories;

1. Interest free period and high interest charge cards
2. No interest free period and lower interest charge cards

If your current finacial situation doesn’t allow you to pay off your credit card in full each month, and you’re using the first type of card, then you need to look closely at swtiching. This is particularly important if you think your current financial downturn might be protracted. Why pay a higher interest rate on credit that is revolving each month when you could be paying a much lower rate?

There are a number of low-rate cards are on the market which have interest rates up to 9 per cent lower than the higher rate cards currently charging 18 to 20 per cent.

Balance transfers

A number of providers also offer even lower rates for the first six months or so on balances you transfer from another card. Like credit cards, balance transfers can also be placed into 2 important categories.

1. Reduced “introductory rates” for a set period (say 6 months) then interest charges revert to the standard credit charge that appies to that particular card
2. Reduced rates for the life of the balance transfer.

If you do decide to take advantage of the second type of card, offering a reduced rate for life of balance of transfer, you should consider not using this type of card for additional purchases until the debt you transferred is fully paid out. The cards offering this type of payment arrangement usually don’t have lower rates. Typically you will find that while the interest you pay on the balance transfer will be around 7 per cent (currently), the charge for additional purchases is likely to be around 20 per cent. But here’s the catch, the payments you make go to reduce your original balance transfer amount. New purchases and interest accrue and attract further interest at the higher amount.

In general, if you’re not able to pay your credit card each month switch to a lower rate card. If you think you’re still going to need to use your card for purchases now and then, go for the introductory low rate. If you can avoid using your card while paying off the balance transfer from your old card – consider the low rate for life of balance transfer type but don't ever use it for new purchases.

Greedy but not stupid

While the beginning of an economic slowdown has been enough to convince the Reserve Bank of Australia (RBA) to contemplate an easing of monetary policy, it will want to remain reasonably tight until there is evidence that inflation is moving into its target zone of 2 to 3 per cent. Although the RBA cannot wait for a fall in inflation before it starts cutting rates because it has to act pre-emptively, there is still a lingering inflation problem and downward pressure on prices needs to be maintained. In saying this, the RBA will go for a 25 basis point cut on September 2 then another 25 points in October. Beyond that the Reserve can determine whether it thinks the economy is about to fall into a hole and can then continue to cut rates if necessary.

However, the scope for official rate cuts is complicated by another matter – will the major banks pass on reductions in official rates to their retail lending rates and ultimately to our home mortgage rates? In spite of their recent profit announcement, banks like the Commonwealth Bank of Australia are tight lipped about passing official rate cuts onto customers.

In the 1990s the banks were labeled “bastards” for outrageously increasing fees, closing branches, and getting rid of low value customers. It’s a reputation the banks have only just repaired and a period they would rather forget. They might be greedy but they’re not stupid. If they live up to their threats not to lower lending rates despite what the RBA does, the banks know they’ll be roundly condemned by everyone – both sides of politics, the media and every radio talk-back shock-jock in the business.

(references: Sydney Morning Herald 18 August 2008; Canberra Times 17 August 2008)

keeping your previous home as an investment property

Our customers upgrade and move homes for all sorts of reasons and many of them keep their original home as an investment property. They are generally aware that in most cases, the cost of servicing the existing debt on their old home then becomes deductible for tax purposes. However, many have not considered the capital gains tax implications of this kind of arrangement.

The previous home was their principal place of residence, and if sold, would normally attract no capital gains tax (CGT). Now that the home is being used for investment purposes, any future sale of that property is most likely going to trigger a CGT event and some amount of tax will probably be payable. How this is calculated can be complex but it is important to note that CGT will be calculated on the difference in value of the property from the date it was first used as an investment and the sale price when it is finally disposed.

If you are considering such an arrangement it will be important for you to establish the value of your home at this time. To do this you should have the home properly valued by a quantity surveyor or a registered valuation expert.

As the amount of tax you will pay in the future depends on current and future values, it will be ideal to for your house to be valued at as high a price as the valuer can professionally allow. This will help minimise the difference in the sale price and the current price and therefore help minimise any future capital gains tax.

As always, before you make any decisions regarding investing your money, consult your accountant or financial advisor and get advice best suited to your individual circumstances.

Rates on fixed loans start to fall

It seems bank customers have felt for some months that the Reserve Bank (RBA) might be about to cut interest rates if figures from the Australian Bureau of Statistics (ABS) are any indication.

Data released this week shows 11.7 per cent of new mortgages approved in June were at a fixed rate, the lowest market share for this type of product since October 2005. That was a big fall from March when fixed rate loans commanded 23.9 per cent of all new housing finance commitments.

The ABS data showed fixed rate loan numbers have fallen for three successive months, even though the major banks have lifted their standard variable lending rates independent of increases by the RBA.

In response to this falling demand for fixed rate products, ANZ Bank and Westpac Bank have both lowered their rates on a number fixed rate terms - up to half of one per cent on on ANZ’s seven year term. However, ANZ says changes to fixed rates are due to a reduction in the cost of funding.

Will this influence the major banks to pass on rate cuts to variable rate mortgages when the RBA lowers rates next month? Don't bet your house on it.

RBA to flag rate cuts

We think the Reserve Bank of Australia (RBA) will leave its key interest rate unchanged after its monthly board meeting today. However, in a measured response they will announce that they are moving to an "Easing Bias" and may even suggest lower rates are on the way. In no uncertain terms, that will be welcome news to borrowers coping with interest rates at a twelve year high.

So the RBA will leave its key cash rate at 7.25 per cent for a fifth straight month. Rates were last raised in March this year, the fourth of four straight increases that started in August 2007. However, depsite inflation still running above the RBA target of 3 per cent, it is expected the central bank will highlight the downside risks to economic growth after several weeks of dour readings on economic activity.

Despite calls in some quarters for a rate cut today we think they are more likely to stay on hold at least one more month. A rate cut today would send an ominous signal about the outlook for the economy in the short term. Also, as the ANZ reminds us, “We do have to remember inflation is at a 16-year high, so the RBA is not going to be rushed into cutting interest rates".

However, while inflation will be a key focus, we feel there are two important issues (among the many) playing on the RBA’s mind. One is the interest rate increases that have been added to bank margins in addition to recent increases in the cash rate. The other is the further deterioration of credit conditions due to continuing fallout from the US credit crisis. Both these will begin to have a significant impact on demand as they play out in the domestic economy and put significant downward pressure on future inflation.

The RBA has raised the cash rate 12 times since May 2002, and last cut it in December 2001. My eldest boy was only 8 back then!

5 year fixed rate blues

Recently we had a bit of a blue with a customer about the interest rate he was being charged. We wrote his loan shortly before the onset of the US financial crisis and, all things considered, the rate was very competitive. But he was with a non-bank lender and his rate has climbed a bit lately – about the same as other non-banks but slightly more than the standard banks. He has since been approached by another bank (a reputable and substantial bank) about fixing his interest rate. Nothing wrong with a little bit of competition between lenders.

However, this discussion took place about 8 to 10 weeks ago when (strangely) some financial analysts were still forecasting a rate rise or two. We haven’t been thinking this way for a while and urged our customer to take time and consider because what the intervening bank was proposing was a 5 year fixed rate marginally lower than that which he was currently being charged.

In view of recent economic data, some commentators have suggested the Reserve bank will need to cut the cash rate to 5 percent from the current 7.25 (see previous post). This morning Alan Kohler said “the cash rate will need to be around 5 per cent this time next year, possibly in the 4s”.

To cut to the chase, our customer was panicked and took the advice of the other bank and moved to a five year fixed rate at close to 9 per cent. I wonder how a fixed rate of nearly 9 per cent will compare to the prevailing discounted variable rate in 12 months time and how the advice of the other bank will be viewed.

Bravo Messers Carr and Cooke!

In February this year, we ran an article on our website about the prospect for interest rates. Counter to the arguments at the time it was titled “Interest rates to ease by end of 2008”. We based this claim on statements by two economists - Adam Carr of UBS and Andrew Cooke of Goldman Sachs-JBWere.

Speaking at a conference in Sydney in February this year, Cooke said he would "throw out the controversial point" that rates may be easing as we get to the end of 2008 even though the Reserve Bank (RBA) has signalled very strongly that further interest rate rises are likely. He argued that "as we go through the remainder of the year, consumer demand may slow too much…so things [might] change pretty quickly.

At about the same time Adam Carr, senior economist at UBS, was making similar, wild claims stating, “inflation isn't really our [the consumers] fault and that crunching demand through tighter monetary policy [higher interest rates] is only part of the answer". At the time Carr was concerned that to curb inflation the nation was faced with the challenge of a significant, policy induced slowing of growth (and rising unemployment) just as the global economy is slowing and credit markets are contracting in the wake of the US sub-prime mortgage crisis. Talking later on the ABC Radio program, “Counterpoint” Carr was concerned that the RBA would be faced with the need to quickly reverse its stance on monetary policy to avoid stalling the economy.

This indeed is what now seems to be happening. On the back of some seriously bad economic data, several commentators are now saying we can expect rates to fall by the end of this year. Some are even talking recession. Although it should be noted that many of these same commentators were predicting that rates would still be rising at this time. Remember it was only several weeks ago that ANZ came out and said that we were facing one or two more rate rises before this Christmas. While the ANZ still feel that rate cuts are not due until early next year, they have certainly backed away from their earlier forecast.

Conditions now are looking so different to that of a few weeks ago that Terry McCrann believes that when the RBA meets on Tuesday next week what we are likely to see "is a very clear statement that the economic and policy cases have now been made for a shift to lower interest rates” and that “a rate cut at the September meeting …is certain. [Further] it won't be the last and it could be a half of 1 per cent[!]”

However its not yet that clear a picture. In the same week of the news about the sharp slump in retail sales, a fall in borrowing, decreasing house prices, and stretching payment terms, The TD Securities-Melbourne Institute monthly inflation gauge was released stating that inflation rose 0.4 per cent in July, after a 0.5 per cent increase in June. Annual inflation ticked down to 4.6 per cent from a record high of 4.8 per cent the previous month – still well above the RBA target band of between 2 and 3 per cent.

Earlier this year the RBA needed to tap the interest rate brake on inflation. Painful though it has been no one would argue with that. What seems to be happening now is that they have come to the conclusion that they may have tapped the brakes once or twice too many. To stop the economy coming to a halt and perhaps even going into reverse (a recession), we’re going to get a nice little surprise just before Christmas – if the pundits are right, the RBA will lower rates sometime between September and December this year. Bravo Mr. Carr! Bravo Mr Cooke!

(references: EquityLend.com.au, Feb 14 2008; HeraldSun, 1 Aug 2008; smartcompany.com.au, 1 Aug 2008)