Back to the future on home loans as fixed rates set to take a back seat again
We are clearly heading back to one preCovid future – the world we used to have where almost all home loans were variable rate ones.
Before Covid literally flew out of Wuhan – and, more particularly, the Reserve Bank did truly extraordinary things to interest rates – the vast majority of home loans; to first home buyers, owner-occupiers more generally, and to investors – were variable rate ones.
Indeed, the split between variable and fixed rate loans was pretty constant year-to-year – at four or five to one. For every $25m in variable rate loans, the banks would write around $5m in fixed rate ones.
Then came Covid and the RBA slashing its official cash interest rate to all but zero.
More important is what the RBA did to lock in that 0.1 per cent – and all but ‘free money’ to borrowers – for a minimum three years.
It wasn’t just RBA Governor Philip Lowe’s promise to keep the cash rate at near zero for three years, until early 2024 – and yes, governor, it was a promise.
It was also the way the RBA acted to keep the three-year Commonwealth bond yield at that same 0.1 per cent – a policy abandoned only last November when the market forced the RBA’s hand.
And it was also the way the RBA directly lent the banks ultimately a total of $188bn – that’s with a “B” for billion – at the 0.1 per cent, locked in for three years.
The banks were very happy to slap on a 2-3 percentage point margin and shovel it out the door to home buyers.
Let me do the maths. Pay the RBA 0.1 per cent on $188bn; that’s just $188m a year. Lend it at, say, 2.5 per cent; that’s income to the bank of $4.7bn (that “B” again) a year.
Bottom line: a juicy, almost risk-free, $4.5bn of gross profit – all courtesy of the RBA.
Importantly, the banks didn’t care whether they were writing a variable-rate loan or a fixed-rate one – as long as
the fixed rate one was for three years or less.
They could not lose money either way if rates suddenly started surging.
With a variable-rate loan, they would just put up the rate, as indeed they have been doing these last couple of months.
With a fixed-rate loan, they had it financed with either the $188bn from the RBA with the 0.1 per cent cost locked in for three years. Or they had borrowed in the market fixedterm money at low rates, if not quite that low, thanks to the RBA’s bond-yield action.
So we saw a completely unprecedented surge in borrowers choosing fixed-rate terms
The website savings.com.au shows the surge in fixed-rate home loan borrowing starting in mid-2020, then the truly huge leap came in mid-2021 and ran through to the end of the year.
In March 2020 – effectively the last pre-Covid month – banks wrote $30bn in variablerate loans and just $4.6bn in fixed-rate loans.
By July of that year, the fixed-rate total had grown to $14bn, more than half the $24bn variable-rate loans.
But the really big jump came in 2021, after the RBA locked in that 0.1 per cent number in November 2020 and the banks duly responded by shovelling out three-year money at pretty much the same interest rate as their variable-rate loans.
As savings.com.au shows, the monthly total for fixed rate loans peaked at $26.3bn in
July 2021 – just shy of the $30.8bn in variable rate loans.
Now, as rates – and especially rates for fixed-rate loans – have started surging, we’ve gone straight back to 2019.
In April this year fixed-rate loans were down to $8bn while variable rate loans were nearly $41bn.
So far the RBA has only lifted its cash rate by 0.75 per cent, to 0.85 per cent. It will hike again on Tuesday, probably by 50 points, to
1.35 per cent.
Variable rate loans are mostly priced off the cash rate. They have all mostly gone back over 3 per cent – depending on “discounts” and “offers” to new customers.
They will go up again by whatever the RBA does on Tuesday.
But fixed-rate loans have surged by much more. That’s because they are priced off the bond-yield curve and what the banks have to pay for their own fixed-term borrowings.
And the bond yield has surged to price in what the RBA is expected to do to its official rate over the next two or three years.
Australia’s biggest bank, the CBA, has hiked its threeyear fixed rate to 6.54 per cent, with similar rises on all the other terms.
CBA, and indeed all the banks, is really saying it does not want you to take a fixedrate loan.
And why would you, when you could get a variable rate loan as low as 2.79 per cent with CBA – albeit only under special conditions, and which will be over 3 per cent after Tuesday.