Blog: Banks increasing Interest Rates
4 October 2017
A question we have received a lot this year is “Why has the bank increased the rates on my home loan?”.
It’s a valid question as rates haven’t officially increased for a long time. As the graph below shows, the official cash rate hasn’t changed since August 2016 when it was cut by 0.25%.
So then, why are some interest rates still going up?
One of the reasons has a lot to do with the significant growth in investment and interest-only lending.
Interest-only loans are an attractive form of mortgage lending for many, as they reduce your monthly cash flow commitments. That said, an interest-only loan also significantly increases the total cost of a loan over its effective life. Feel free to try our Loan Repayment Calculator to see what I mean.
Let’s say you were looking to purchase an investment property. Your accountant or financial planner might recommend that you take a loan with interest-only payments; The idea being that this debt gives you a tax-deduction, so it would be inefficient to restrict your cash flow by paying it down when you could use those funds to pay your home loan mortgage instead.
It’s a sensible arrangement in this particular case. However, in recent years Australia has seen a significant increase in interest-only owner-occupied home loans. This is dangerous territory… the borrower may have more cash flow available to them, but to what end? They can spend it on living and lifestyle expenses, but in the meantime the entire debt stays put as it’s not being paid off.
The government has recognised this trend and has been concerned with the level of indebtedness that Australian households have taken on. If left unchecked, this could create significant economic problems for borrowers and the government alike. Interest rates won’t stay this low forever… they’ll start heading upwards eventually.
That’s why APRA (The Australian Prudential Regulation Authority) – the government body responsible for ensuring sound governance of our banking system – have stepped in.
APRA tightens the rules
In late May 2017, APRA advised all Australian lenders that interest-only loans must be restricted to 30% of new residential mortgage loans. At the time, interest-only loans accounted for closer to 40% of all new loans approved, so the banks had to change their lending criteria quickly. APRA had already set growth in investment lending to a 10% “speed limit”, so this new requirement added another layer of complexity to the mix.
Let’s pretend that home loans are fresh fruit. Firstly, that would make this a food blog, so I’d have a lot more readers. More importantly though, have you seen how quickly the price of bananas fluctuate? As we’ve seen in the past, bananas are very expensive after a cyclone comes along. The cyclone causes a massive reduction in the supply of bananas, so the price of the remaining bananas goes up, which limits the number of people who will buy them. It’s the law of demand: The higher the price of a good, the less people will demand that good.
As with bananas, the decision makers at the banks probably know a thing or two about the fundamentals of economics.
Quick conclusion: Interest-only and investment lending is now more expensive.
It wasn’t that long ago that interest rates were generally the same for any loan, regardless of the purpose or structure. Interest-only and investment loans were priced at the same rates as owner occupied loans. But this has now changed as a result of the restrictions set by APRA. What this means is that there are effectively four types of rates on the market (for residential loans, and excluding fixed rate options), which are summarised below:
- Investment – Interest Only (4.2%pa – 5.00%pa)*
- Investment – Principal and Interest (3.8pa – 4.5%pa)*
- Owner Occupied – Interest Only (3.9%pa – 4.5%pa)*
- Owner Occupied – Principal and Interest (3.7%pa – 4.2%pa)*
* These are approximate interest-rate ranges as at early October 2017
Further Changes to Mortgage lending policy?
The restrictions from APRA could just be the beginning. APRA could introduce new or amended restriction at any time.
Meanwhile, the growing calls for a Banking Royal Commission must surely be scaring the daylights out of the big banks. Just like a 4-year-old in the weeks before Santa comes, the banks are now on their best behaviour. A perfect example took place a week ago when the Big 4 finally scrapped ATM fees.
All this combined has led to significant changes in lending policies and rules across all lenders.
In this environment, more than ever before, it is crucial to get quality advice around your finance options. There are now significant differences in policies between lenders that could affect your loans structure, your total borrowing capacity, and even your ability to be approved.
So what can be done?
Reality is, with all the noise and no one-size-fits-all solution it’s pretty hard for someone to know if they’re getting the best home loan deal.
Fortunately, there are a few things you can do about it. If you are completely unsure then get in touch with us and we’ll be happy to help. A few recommendations include:
- Switch to Principal & Interest (P&I)
Lenders have priced their loan products to increase demand for principal and interest repayments, so you will find that all the low rates you see are P&I. Yes, it increases your monthly repayments, however by paying down the loan you will ultimately be paying much less interest in the long run.
- Haggle with your current lender
Some banks have been a little cheeky and used these regulations to increase rates in existing loans. If your current mortgage has been around for a few years or more then you could be paying well about what is currently available. It’s surprising how a simple phone call may result in getting a significantly better rate, particularly if you mention that you are considering refinancing.
- Refinance to a new lender
If you’ve called your existing lender and are still not happy with what they have offered, then you might just be better off refinancing to a new lender. We can give you some options around this.
- Consider fixing some of you loan
Some of the lenders are offering some pretty attractive fixed terms that are the same or cheaper than many variable investment and interest-only loans. There are risks to consider surrounding fixed rate options, however with the likelihood of further increases down the track, it may be the time to consider locking in a near historical low rate.
- Set up an offset account
If you have some money sitting in a savings account, it can be a suitable option to put the same funds into an offset account. The effect is it reduces the balance of your loan and interest charged on your mortgage by the amount you have in offset (eg $10k in an offset account reduces the balance of a $200k loan to an effective balance of $190k). The rationale being that a savings account may earn you around 2.0%pa, minus tax and less the effect of inflation… so you’re not really going anywhere. Whereas an offset account saves you interest at a higher rate with no tax payable on the saving.
I hope this provides a little clarity around why mortgage interest rates have been increasing recently. As I said, please feel free to contact us here or call the office on 1300 85 83 81 to discuss options that are tailored to your scenario.
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About the author
Tim has an in-depth knowledge of the Australian mortgage sector makes the loan process simple and stress-free. It pays to have him on your side, whether for the purchase of a new home or seeking a better deal on your existing loan.
Known for his accessible style and warm approach, Tim believes that educating people about their mortgage will help them to achieve their financial goals sooner. By sharing his expertise openly, some of the people he educates will likely become his clients. It’s a win-win approach. Valuable information, no obligation.