This week’s column.
My father sometimes responded to my cheekier moments with an old Jewish saying that greatly amused him “If you’re so smart, how come you’re not rich?” Dad dedicated his own smarts to academia, and was happy with the tradeoff he made in favour of interesting, secure work ahead of serious money.
It’s surprising how little edge an economic training gives you in making money. I reckon I’ve got plenty of good ideas about how to improve public policy what to do on tax, R&D and intellectual property. But often it doesn’t give me any ‘angle’ a way to capture the financial benefit of my knowledge.
But every now and then something comes along that looks like a money making (or saving) opportunity. One’s been sitting in the ‘in-tray’ of most people with decent sized mortgages for some months now. But it could be disappearing. So if you’re interested, act soon.
If you’ve got a variable rate mortgage, chances are you’re paying around 6.7 percent. (If you’re paying over 6.9 percent you’re probably being taken for a mug).
But right now you can secure three year fixed rates on your mortgage for less than 6.5 percent. (Declaration of interest: I run a discount mortgage broking company. Fixed rate loans don’t earn us more commission than others).
It’s unusual for fixed rates to be below variable rates.
Fixed rate lenders expect a margin to cover them for the risk they take and relieve you of that variable rates will change adversely during the fixed term.
After this risk margin is accounted for, you’d expect fixed rates to equal the rate that the market expects variable rates to average over the fixed term. If it paid more you’d some fixed lenders would switch to variable, and if it paid less, they’d switch the other way.
But the market isn’t expecting variable rates to fall. BT Financial Group’s advice last Thursday even after sluggish National Accounts numbers was fairly representative of economists’ opinion, “[t]he next move in rates is still more likely to be up, rather than down, and increasingly, sooner, rather than later.”
So what’s going on? There is a massive global liquidity glut. In the wake of the Asian crisis, Asian investment fell by a mind boggling 10 percentage points of GDP whilst their colossal savings rates barely moved.
That’s created huge surpluses of money.
Unable to be invested at home, Asian money has flooded into foreign money markets. Asian central banks have bought the debt George W. Bush’s Administration has plunged his government into to finance tax cuts for the rich and military tours of duty for the poor.
It’s been called the biggest vendor finance scheme the world has ever seen. Asian lending to America keeps its economy afloat whilst preventing Asian exchange rates from rising. That keeps America importing Asian goods.
The same tsunami of money has pushed Australian fixed rates on housing loans below what I’ve argued is their fundamental value (ie the expected average variable rate over the fixed period plus some small margin for risk).
In theory traders should have arbitraged this opportunity away by borrowing long and lending short thus increasing fixed rates (variable rates shouldn’t move because they are anchored by the Reserve Bank’s cash rate). Perhaps the sheer weight of funds available swamps the arbitrageurs’ capacity. Perhaps the bond traders don’t believe the economists’ forecasts. Who knows?
Be that as it may, if you agree with the economists that there’s no reason to expect rates to fall, you can do a bit of arbitraging by fixing yourself and always consider refinancing to get the best rate.
And the days when fixed rate lending meant you couldn’t make additional repayments or use redraws or offset accounts are now gone, thanks to competition. And because fixed rates lower borrowers’ risk, some lenders now allow fixed rate lenders more borrowing before ‘maxing out’ their serviceability.
However you may need to act fast. It looks like some of those equilibrating forces mentioned above are starting to kick in. Driven by rising long term bond rates, fixed rates are now rising.
And remember fixing might be a good bet, but it’s still a bet. If it was a one way bet, chances are it would be gone by the time you read about it in the paper! Variable rates could still fall by enough to make your fixing a losing bet even though economists don’t expect they will.
By the same token, if you stay variable and rates remain steady or rise, you’ll be kicking yourself you didn’t lock in and enjoy a lower rate. There are no guarantees, but one rarely gets the opportunity to lower risk and increase expected return with the same transaction.
And, if you win your bet, you can put your tongue in your cheek and say to those who missed out “if you’re so smart, how come you didn’t fix?”
Nicholas Gruenis not an investment advisor. His comment is general and you should consult an investment advisor regarding your specific circumstances.