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)