The fix is on for bank mortgage rates: should you take the deal?

Any home loan rate that has a 'four' in front of it is always going to attract a lot of interest.

So says the Commonwealth Bank’s general manager for home loans, Clive van Horen, after Australia’s biggest mortgage lender joined the other major banks by offering a 4.99% two-year fixed home loan rate this month.

The major banks took a while to join the fixed-rate cutting party, but now each is offering a two-year fixed rate starting with 'four' as they try to get more borrowers to lock in their mortgage rate and lender for anywhere from one to five years.

Van Horen tells Property Observer there has been a pick-up in borrowers opting for fixed-rate mortgages since the bank began cutting its fixed rate.

“Customers want to get certainty,” he says.

There is a growing proportion of borrowers who are hedging their bets by splitting their loan and keeping part of it on a variable rate, he says. 

“That way they get the best of both worlds.”

Similarly, Westpac, which was the first of the major banks to offer a sub-5% fixed rate this year is seeing an uptick in people fixing their home loans at its current 4.99% two-year fixed rate.

“At the moment (and not surprisingly) the two year deal is the most attractive but historically the three year fixed has been the most popular as people look for both security and peace of mind when it comes to longer-term repayments,” Westpac spokesperson Danny Johns says.

A spokesperson for NAB says it is already seeing increased demand for fixed rates after cutting one and two year fixed-rates earlier in the month.

"Generally, the three year rate is the most popular, but at the moment with the two year rate at 4.99%, it has generated a lot of interest."

Borrowers can get even cheaper fixed rates if they’re prepared to look outside the major banks. Mutual lender ME Bank has cut its three-year fixed rate to 4.99%, while iMortgage, the online lending arm of ASX-listed non-bank lender Homeloans Ltd, is offering a two-year fixed rate of 4.79% - currently the lowest rate in the market. 

The right set of curves 

Lenders are able to offer these lower fixed-rates because short-term funding costs have come down. 

Nomura banking analyst Victor German explains that banks price their fixed-rate home loans off a swap curve, which is essentially a measure of yields paid between banks for short term funding of different maturities.

He says the current two-year swap yield has dropped below 3% - currently it sits at 2.97% - while the three-year year swap is at 3.15%. 

So even at a two-year or three-year fixed-rate of as low as 4.79% there is a healthy margin for the bank or non-bank lender – and margins have been increasing as the recent financial results put out by the Commonwealth Bank, ANZ and NAB attest. 

German says the fixed-rates being offered by the banks is simply a play to get more business through the door in an environment of lower credit growth. The move also allows banks to lock customers in for a fixed period of time with the added benefit of cross-selling them other products and improve that all-important bank ratio: number of products per customer. 

The question borrowers may be asking themselves is: should I now consider fixing all or some of my mortgage repayments and take advantage of the low rates on offer?

But there might also be an argument for waiting a while longer – given the margins available, further fixed-rate cuts seem a distinct possibility.  

To fix or not

It’s a difficult argument for Australian borrowers to resolve. 

Many who fixed pre-GFC got badly burned when fixed rates tumbled as the RBA took an axe to the cash rate to keep the economy and housing market afloat. 

That’s unlikely to occur to the same extent because, firstly, the cash rate is already at the GFC low of 3% and, secondly, it appears that the global economy is more or less in recovery phase. 

Last week’s statement by RBA Glenn Stevens to a parliamentary committee suggested low rates are here to stay and may fall further if the economy fails to fire, but that any further cash rate cuts could be on hold for some time.

Still, with NAB's chief economist ALAN OSTER tipping a cash rate of 2.25% by year-end, fixed-rate borrowers could lose out if such a scenario eventuates.

Currently, the enticements of fixed-rates are the low sub-5% offers in the market and the certainty of repayments. 

It remains, however, a marginal product with the majority of borrowers; 80% to 85% choose a variable offer of some kind. 

According to audience figures compiled by comparison website HomeLoanFinder.com.au, the three-year fixed-rate product is by far the most popular, but there is also some interest for attractive two-year and five-year products.

Fixed-rate product popularity:

Source: HomeLoanFinder.com.au

Even with fixed-rates this low, Australians are reluctant to take out a fixed-rate home loan. 

Mortgage Choice CEO Michael Russell says borrowers are not “knocking down the doors” at banks to re-finance. 

Demand for fixed-rate home loans peaked at around 20% over 2012 according to Mortgage Choice figures, but is now trending down back towards long-term averages of around 15%. 

Compares this with the UK, where record low fixed-rates of around 4% are enticing over 90% of borrowers to fix their rate. 

Why the relatively poor take-up of fixed rates in Australia? 

There are a number of sensible arguments for not taking out a fixed-rate home loan even with the low rates on offer, beyond the obvious risk of missing out on repayment reductions if the cash rates fall. 

Firstly, there is the inflexibility of the products such as the seemingly paradoxical penalties for paying off your home loan earlier and the restrictions on making extra repayments.

Plus there is the fact that fixed-rate home loans are not included as part of the government ban on mortgage exit fees, which began in mid-2011, meaning borrowers cannot refinance without incurring heavy penalty fees. 

But, borrowers should also keep in mind that though the gap between the standard variable rate and the fixed rate may appear quite large in advertising material and on websites, if they are of good standing they may be able to negotiate anything from 80 to 100 basis points off the benchmark rate wiping out much if not all the benefit of fixing. 

And remember, the really big discounts are the ones negotiated behind closed doors – between borrower and bank manager – not those advertised on the windows of bank branches.

“The discounts off standard variable rate are compelling at the moment,” says Michael Russell to emphasis this point. 

What happens when your fixed term expires?

Having weighed up all the options (and hopefully spoken to a reputable mortgage broker somewhere along the line) if you do decide to take out a fixed-rate home loan remember to keep in mind when the term expires. 

Once the term expires, most borrowers will revert to the standard variable rate and plus possibly whatever discount they were entitled to under their fixed-rate mortgage contract. 

Depending on what has happened to rates since you fixed, the difference could be quite large meaning higher mortgage repayments. 

Westpac contacts borrowers about four to six weeks before their fixed rate term expires. 

“We write to them asking them whether they want to re-fix at any new rate that may then apply or if not they will then move to our applicable variable rate,” says Johns. 

“So if someone was moving off a fixed rate now they would go on our current variable rate of 6.51% - and if they are a package customer they would get a discount of 0.7% on that rate, that is a variable rate 5.81%. 

“But if they wanted to get a reasonable fixed rate deal they could currently get the two year at 4.99% (inclusive of a package discount of 0.2%) or on a three year deal.” 

Van Horen says that when a Commonwealth Bank customer’s fixed-rate term is about to expire, the bank notifies them that the loan will revert to the floating variable rate plus whatever discount was agreed initially. 

“They can either choose the variable or fix again.”

This is a vast improvement on the days when it was a lot harder for borrowers to switch lenders and the rate reverted to the floating variable rate without notification.

But you still need to keep checking your mortgage statements just in case - not all lenders may be as proactive.