The cash-free rate as measured by the CASH RATE as set by Reserve Bank of Australia (RBA) is at the lowest level since the 1990’s. It is currently sitting at 1.5%. For the past 7 years since November 2010, the RBA did not move the cash free rate, in addition, the cash free rate had decreased 12 times from 4.75% to the historical lowest of 1.5%.
Historically in the past, when the Reserve Bank of Australia changes the CASH RATE, the other banks will follow suit to follow it, meaning that if the Reserve Bank increases or decreases the cash rate by X basis point, the other banks will follow suit and reduce their home loan with a similar basis point.
However, recently there is a trend in the banking sector that banks will adjust its standard variable rate and other home loan rates independent of the decision from the Reserve Bank of Australia, and the banks justify this decision behavior on the increased funding cost and change in the risk tolerance by APRA.
Rate increases at National Australia Bank
On 16 March 2017, the National Australia Bank increased its standard variable rate by as much 15 basis point, blaming on tighten of credit regulation and funding cost.
The bank’s standard variable mortgage rate for owner-occupiers will increase by 7 basis points to 5.32 per cent per annum, effective next week Friday 24 March 2017. NAB said someone with a $300,000 loan on a 30-year term would be paying an extra $13 a month because of this rate increase.
However, investors face a much steeper increase in repayments, with NAB’s variable rate for them jumping from 5.55 per cent to 5.8 per cent, also effective Friday week.
That would cost an investor with a $300,000 loan on a 30-year term an extra $47 each month or $564 per year.
The bank has blamed higher funding costs, in part due to the bank regulator APRA’s moves to crack down on strongly growing investment lending, as the reason for the rate rises, which coincided with a US official interest rate rise earlier in the day.
The danger of prolonged low-interest rate
“A lot of people are becoming complacent thinking the interest rate in Australia will NEVER INCREASE.”
Given that the home loan rate is at the historical lowest, a lot of people are becoming complacent thinking the interest rate in Australia will NEVER INCREASE. However, we need to know that just as recent as in 2008, the cash rate was as high as 7.25%, and the normal home loan rate was around 9% to 10%.
If the Reserve bank of Australia or the banks did increase the Home Loan Rate by as much as 3%, which is similar to what had happened in 2008, then most of us would have a very difficult time in repaying the home loan. That look at the example as set in table 1.
In table 1, we set out the effect of the change in home loan rate on the annualized home loan repayment. In table 2, we set out the effect of the home loan rate change on the percentage of disposable income on annualized home loan repayment.
If we assume that the pre-tax family income is $80,000, the current home loan rate is 4%, and the family has a $1 million dollar home loan.
If the home loan rate increases to 7%, then the annual mortgage repayment would increase by 94% from $40,000 to $77,500, a steep increase of $37,750 per year. At 4% home loan rate, the family will be using 64% of the disposal income to repay the mortgage, however, if the interest rate increases to 7%, then the percentage of disposal income to be used to repay the mortgage would be increased to 124%, a staggering amount.
“That family would have no more income to buy the daily family necessities which include food, clothing and education,”
This means that family would have no more income to buy the daily family necessities which include food, clothing, and education, as they will not only use 100% of the income to pay the home loan, but must borrow additional 25% more from other sources to meet the minimum home loan repayment, and that has not even factor to the account about their day to day family expense.
No food for the family
This problem is the main cause of the subprime crisis in the United States back in July 2008, leading to the massive US recession from December 2007 to June 2009. The SubPrime Crisis happened because people in the US were not able to meet the minimum loan repayment when the rate increased during the time.
This problem becomes more evident as the loan size increases, hence for a $1.3 million dollar loan, the percentage of disposable income over the mortgage repayment would be a staggering 161%, close to double the family’s disposable income.
Would the interest rate in Australia increase in the short to medium term
Hence, the question to ask is whether the Australian banks, in general, would increase the interest rate in the short to medium time frame.
If we must ask that question, it is important to understand that Australian banks get around 40% of the funding from overseas, hence if the interest rate in oversea increases, the probability of Australian Banks to follow suit is very high, as they will have more than enough excuses to hit borrowers with another round of interest rate increases. Hence it is important to look at the recent annoucement by the Federal Reserve.
Since the US recession, the Federal Reserve has kept the interest rate at a very low level, closer to a zero interest rate, and around the world, most of the central banks are embracing the new concept of zero interest rate fiscal policy, however, recently the Federal Reserve of United States had increased the cash rate the third time in a row, and the more important thing to note is that this increase in 15 March 2017 was after the increase around 3 months ago. The Federal Reserve had increased the rate only three times after the Global Financial Crisis.
The Federal Reserve in hinted in saying they will increase the rate on a gradual basis, and there will two more rate increases in 2017 and three more on 2018, and they want to put the interest rate back the normal track.
The Federal Reserve is increasing the rate based the inflation pressure also the positive prospect of the falling in the unemployment.
Hence, it was not a surprise that in Australia, NAB then increased the rate on the same next day after the Federal Reserve increases the rate, they explained that “The difference between what we charge and how much it costs us to fund a mortgage remains under pressure, with intense competition, increasing regulation, and elevated funding costs,” said NAB’s chief operating officer Antony Cahill in a statement.
“By making a series of changes, both up and down, we are seeking to balance these across our entire mortgage portfolio.”
The downward move in rates is a record low 3.69 per cent two-year fixed rate for first home buyers, priced 29 basis points below the two-year fixed rate being offered to other owner-occupiers.
“This is the lowest home loan rate ever offered by NAB, and it will help Australians entering the property market for the first time to achieve their home ownership dreams,” Mr. Cahill said.
Review your home loan
What we like to said is sometimes people will try to get their lowest interest rate when they are settling the house, at the time, they were even picky about a mere 5 basis point, as they would love to get a seemingly very low rate.
But how many people do take the time to review home loan after settlement, and to ensure that the low home loan rate they got at settlement is still low in the marketplace. Probably it has been 1, 5 or 10 years since you settled or refinanced your property, and you never reviewed the home loan, and most likely the rate you got at the time was low, but it might be expensive in the current marketplace.
What EndureGo proposes is that we will review your home loan for free, to see whether any improvement can be made to your home loan.
This is especially important if you are National Australia bank customer. At the moment, it is vital to review your home loan, to see whether you would be able to get a lower home loan rate, and more importantly is that whether you would benefit from a fixed rate to ensure that you do have enough cash flow on hand in the future to feed your family if the bank does increase the rate to a high level in the short to medium term.
As one of the best mortgage broker in Sydney and Adelaide, we would love to hear from you, and it is our mission to ensure that you get the lowest home loan rate, just remember the difference between a 3.65% and 4.4% home loan rate on a $1million dollar loan would be a $3,500 difference in term of interest expense. If the rate does increases in the short to medium term, you would not want your home loan repayment to double up leaving no cash for you to feed your family.
Please give EndureGo Finance a call on 02-8958-1959 or 0410-829-900, or email us on firstname.lastname@example.org.