Should I lock in a fixed rate on my home loan with interest rates so low?

Welcome to Say What Wednesdays – Where we answer your questions about personal finance and the economy!

This week’s question comes from Michael. His question related to interest rates, and to not give away his details I’ll paraphrase: “With interest rates at the moment being currently fairly low on my personal home, do you think it is a good time to lock in a fixed rate, or should I keep it variable?

I can’t give a yes or no answer on this one without knowing more about your personal situation, but can speak generally.

To answer this, we will run through three players in the game;

1. RBA Cash rate
2. Interest rates of the banks
3. Deposit rates of the banks

All three of these are related

RBA cash rate is the core, which then leads on to what banks lend out at, and then also what they offer on deposits placed with the bank.

RBA Cash rate – what the RBA set as monetary policy through OMO and the supply of money
We have been talking about this in recent Furious Friday episodes.

1. We are coming up to 2 years of having the RBA cash rate at 1.5% – Aug 2016 has been on hold since
   • While 1.5 per cent is historically low, is it helping?
   • Unemployment is not falling at the anticipated rate.
   • Inflation is below the [RBA’s] target range and has been for three years
   • Wages growth is at record lows
2. Economic benchmarks to start a cycle of rate rises are straight forward.
   • Annual GDP growth above 3.25 per cent,
   • the unemployment rate falling to at least 5 per cent,
   • wages growth lifting to 3 per cent and beyond
   • underlying inflation increasing to 2.5 per cent.
3. We’re not ticking any boxes – and this is a bit of an issue for the RBA

Bank interest rates

1. These are related to the RBA cash rate, but can move out of ‘cycle’
2. The do follow one another, but the banking deposit rates are what the cost is for lending
3. The two go hand in hand – Banks use deposits to lend (went through this in last Friday’s episode)

Big Four Deposit rates

1. ANZ
   • Deposits: 12m – 2.3%, 24m – 2.6%, 36m – 2.5%
   • Lending: 36m 4.14%
2. CBA
   • Deposits: 12m – 2.2%, 24m – 2.6%, 36m – 2.4%
   • Lending: 24m – 4.04%
3. NAB
   • Deposits: 12m – 2.4%, 24m – 2.6%, 36m – 2.7%
   • Lending: 1 year – 3.89%, 36m – 3.94%, 5 years – 4.09%
4. WBC
   • Deposits: 12m – 2.3%, 24m – 2.4%, 36m – 2.5%

Investment and interest only rates – March banks dropped these by 0.3% to 0.5% on average.

What this means:

1. Anticipation for rates going up isn’t high
2. If lending rates were high in 3-5 years, the anticipation from the banks would be that rates are going back up
   • The bank isn’t going to lose out on money here

RBA Rate indicator – this keeps sliding further and further into the future

1. Has been for the past 12 months: Shows steady for 12 months, then slight change of increase
2. All the way through to end of 2019 – 50/50 chance of raise to 1.75%

The signs:

• GDP – better growth but still below long-term trend
• Retail sales – May be going backwards

But…this isn’t the whole story:

1. Interbank credit spreads are a powerful leading indicator of where mortgage rates are heading.
2. Spread: Difference between banks offer of their borrowing vs lending out money
3. Interbank spreads are getting wider, so mortgages rates may go up.
4. But competition between lenders is high, so this keeps them honest.
   • Other option: They might to decrease the deposit rates

The take away:
Getting back to the question of ‘locking in rate now’

1. Locking in a whole loan on fixed interest can be risky
   1. Breaking costs – Rates go down then you are stuck
   2. Limits debt repayment options
      • While rates are low there is the chance to pay debt back
      • Doesn’t have much of a benefit now, as rates are low
      • i.e. you save more paying debt off when rates are high

2. If you are worried:
   1. Look at what you can afford to pay back in a time frame:
   2. Potentially lock in a portion at a lower rate
      • But make sure it has a 3 in the front of it! (Or, at least, a very low 4% range)
   3. All indicators show that there is unlikely to be a raise
      • Nab has 3 years for sub 4% – this is in line with variable rates –
      • Shows low anticipation of raise in rates