There was a time not so long ago that interest rates movements were a simple thing.
Once a month every Tuesday the Reserve Bank of Australia (RBA) would meet and decide if the overnight cash rate was going up, down or staying the same. Talking simplistically, if the cash rate went up, so did your mortgage repayments. If they went down then, hooray!, your payments went down as well…
Those days of tranquillity are, sadly, well and truly behind us
What happened to those halcyon times?
Two things happened, both driven by our good friends at the Australian Prudential Regulation Authority (APRA) – the regulator of banks in Australia:
Thing One – In Mid 2015 APRA decided that banks were not allowed to grow their property investment loans by more than 10% per year.
Thing Two – In Mid 2017 APRA told banks that interest-only loans must be restricted to 30% of new residential mortgage loans.
APRA put these measures in place, ostensibly, to protect the Australian property market and consumers (we don’t quite agree).
Hold on a second…
Before we go any further it is work classifying the major different “types” of interest rates you are likely to request from a lender:
- Principal Place of Residence (PPOR) Loan– PPOR is the loan you will take out for the house you will live in.
- Investment Loan – these loans are taken out when you are planning on buying an investment property.
These loans can be re-payed in the following pays:
- Principal & Interest (P & I) – monthly repayments are higher because both the interest due on the outstanding loan amount and the balance on the loan itself are repaid.
- Interest Only (I/O) – for a set period, monthly repayments are lower as just the interest due on the loan is paid. After that period repayments are high as you begin paying off the principal.
These rates can be fixed or variable – we won’t go into much detail about the difference – if you are interested you can find out more here.
What have APRA’s interventions done to interest rates?
Before APRA entered the picture these four loan types would effectively attract the exact same interest rate with the only altering factor being the Loan to Value Ratio (higher LVR’s have always attracted a higher interest rate).
Not anymore – in order to comply with APRA’s request, Australia’s banks have made some major tweaks to their interest rates. Below are the current rates you are likely to get on a $500,000 loan (LVR <= 80%) with our major banks:
|PPOR Loans||Investment Loans|
|P+I||Interest Only||P+I||Interest Only|
This has effectively seen interest rates for numerous borrowers go up 60 basis points (or $70,000 in interest over the life of a $500,000 loan) in just 1 year. This is despite the RBA’s cash rate staying at a record low 1.5% over that whole period – insanity.
I am getting a new loan – what should I do?
If you can afford the cashflow hit, you should get a P+I loan.
One thing about APRA’s intervention is that the impact has been swift – interest only loans made up just 17% of total new lending in the September quarter, well below the 30% long term target APRA is looking for. This compares to 45% of new loans just 2 years ago
This herd movement towards P+I is no surprise, I/O loans make no sense after the banks hiked their rates. As per analysis by Macquarie Bank, the ~0.5% differential means a bank customer in the top tax bracket with a $500,000 loan would be $6,000 better off after five years, and $12,000 better off after 10 years taking out a P+I loan vs I/O.
My loan has gotten much more expensive – what should I do?
Those most affected by these APRA changes are the hundreds of thousands of people who entered loan contracts with no idea the APRA would (or even could) manipulate interest rates.
The “simple” answer is to switch the loan to P+I – this has not been happening as APRA had hoped.
The reasons for this are varied:
- Banks have tightened lending criteria – along with adjusting rates to appease ASIC, banks have made it more difficult to get a loan which means switching may not be possible for some people
- Cashflow issues – lots of people who are paying interest only simply can’t afford to switch to principal and interest
- Knowledge – studies have shown that just 20% of Australians know what interest rate they are paying. A lot of people won’t even know their rate has gone up significantly and;
- Apathy – even people who know what they should do are too lazy to take simple steps which will save them thousands of dollars each year.
Where to for interest rates from here?
Our crystal ball is in for repairs, however – APRA’s restrictions appear to be working with 35.35% of all loans now interest-only, rapidly approaching their 30% target.
Once this target is hit, we could see banks start pricing their I/O loans lower to get more market share from their competitors.
This, combined with the record low cash rate that could stay put till 2020 makes us believe there may be lower rates on the horizon.
What the hell does this all mean for me?
If you are looking to buy a property getting the right structured loan is difficult and getting the wrong one can be very expensive.
If you already have a loan there is a strong possibility that your structure or rate is not the best out there. As per the table of interest rates, getting either of these right can save you thousands of dollars per year.
The information contained on this page is of a general nature and may not be appropriate for your personal circumstances. You should obtain personal financial advice before acting on this information.