Beware lender offers on fixed rates

One in three new mortgages are fixed – but investors need to understand the terms of these arrangements.

Releasing the NAB results on Thursday, CEO Ross McEwan ­revealed that one in three home loans going out the door at the bank were fixed — what’s more, McEwan expects the trend to extend in the months ahead.

This is a major change: traditionally, about 90 per cent of loans are structured on variable interest rates.

But times are changing. Under normal circumstances, when banks predict that the RBA is in a cutting cycle, they will offer fixed rate loans at a lower price than variable rate loans.

With the official cash rate at 0.1 per cent, there is not much more downward movement available to the RBA, yet fixed rates are being priced at more than 0.5 per cent cheaper than variable rates. So why is this the case?

Ken Peng, managing director of mortgage broker Vestyn Fin­ance, says: “Banks are not following traditional loan pricing rules on fixed-rate loans due to the large amount of cheap financing that the RBA is providing. Banks can access the $200bn Term Funding Facility with three-year loans provided to them at 0.1 per cent.”

As a result, banks are competing to lock in borrowers on three to five-year terms by offering them cheap fixed rate loans. Even though the rates are attractive to the borrower, don’t worry about the banks, they are still making money, having accessed the funds from the RBA at close to 0.1 per cent interest.

Commonwealth Bank has fired the first shot by dropping its four-year fixed rate to 1.99 per cent (which has now been matched by Westpac, a tad lower at 1.89 per cent).

Not to be outdone by the major lenders, some of the second-tier banks have upped the ante with some hot deals of their own. Suncorp is offering 1.89 per cent on two-year fixed loans while the same rate can be achieved with Bank of Melbourne on a four-year fixed loan.

Peng says: “I am advising clients to wait another week or so to see what deals other lenders will come out with. Each bank has their own unique lending criteria around things like the maximum loan-to-value ratios and serviceability calculations.

“So the more lenders that offer sub-2 per cent fixed rates, the more options we have to match the borrower with the right lender to suit their circumstances.”

And if the offer of cheap loans is not enough to entice borrowers, subprime borrowers will be able to access loans more freely next year when responsible lender rules are wound back and use the record low fixed rates on offer.

We don’t know what will happen in the future, but one scenario could be that when the fixed rate loans expire and revert to the variable rate (which may be 50 per cent higher than their fixed-rate loan), we may see history repeat and the property bubble pop with a wave of defaults. Meanwhile, for most borrowers, before jumping in and switching your existing loan over to a fixed rate, there are a few things to consider.

First, banks will usually limit the maximum amount of extra repayments you can make on a fixed-rate loan to somewhere between $10,000 and $20,000 a year. If you are aggressively repaying debt, forecast how much extra you are likely to repay above the minimum over the fixed period and keep at least that amount as a variable component.

Keep in mind, too, that you are “financially handcuffed” to the bank for the duration of the fixed-rate period, given the substantial break costs banks normally levy if you try to exit the fixed-rate loan early.

If your personal or financial situation is likely to change over the fixed-rate period and the sale of the property is possible, be wary about fixing your loan. The banks will not hesitate in applying significant break costs if you sell and do not replace the property with another one for them to transfer the fixed-rate facility across to.

For those looking to acquire or refinance several properties over the next few years, your bargaining power on new debt may be weaker if you have already locked in existing debt under fixed-rate facilities. The new lender will not be able to sweep up all of your debt in a refinance and, as such, may not offer the best deal compared to if they were able to do on a total refinance of your debt.

Although 2020 has been a year of challenges, borrowers are now able to take advantage of record low rates on their debt but should be aware of the potential headwinds that the property market may face if there is a significant increase in subprime lending.

James Gerrard is principal and director of Sydney planning firm www.financialadvisor.com.au