If you’re so smart, fix your mortgage

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.

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Joel Parsons
2022 years ago

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.

Depends what bank you’re with. I work for one of the big 4, and they still have a number of extra restrictions on fixed rate loans including:

– No more than $5,000 in additional repayments can be made per year.
– Customers are not allowed to make repayments on fixed rate loans early, any early payments go to reducing the principal while the normal payment is still due as usual.
– Customers on fixed rate loans cannot change the dates their payments are due or their payment frequency until the fixed rate period has expired.

These three restrictions (none of which apply to variable rate mortgages) cause all hell and confusion for some of our customers, few of whom understand these differences when they are explained to them during the application process. The existence of Mortgage Brokers who are often even less conscientious about explaining product differences further exacerbates the situations. Afterwards, I can often get stuck spending up to 30 minutes explaining to a bewildered customer why they have been charge penalty fees, are in arrears or cannot access funds they thought were available for redraw.

Nicholas Gruen
2022 years ago

Yes Joel,

No doubt about it, there are plenty of inflexible products around. I was referring to the flexible ones. You can get a three year fixed rate loan at 6.55% with a full offset account.

I know some mortgage brokers who even tell their clients about these products.

But none of the big 4 offer such flexibility.

Bring Back EP at LP
Bring Back EP at LP
2022 years ago

Nicholas,

can you help me out with something regarding your brother.

it was told in the markets when he was at the RBA he had completed a PhD in physics gave it away and then did a PhD in economics.

given his work I was willing to believe this.

Is it indeed true?

Fyodor
2022 years ago

Nicholas,

Sorry, bit late to this one.

The flattening of the yield curve, with short-end yields rising and long-end yields falling, is not that unusual. It actually says some interesting things about interest rate expectations.

Short-end yields are effectively set by central banks via monetary policy, but the market prices the long-end yield. With the cash rate now roughly on a par with the three-year CG bond yield, the market is arguably telling you it does not anticipate significant interest rate increases over the next 2-3 years.

Arguably, given a rising curve is normal, the market may be anticipating interest rate declines in the next 2-3 years. This suggests that there’s probably not a lot of benefit from locking in to a fixed rate now.

bring Back EP at LP
bring Back EP at LP
2022 years ago

Fyodor in recurring surpluses CGS is not the place to look. The Swaps market is better and I am told it is positive.

Supermac would not be hinting of increasing rates if a slowdown was looming!

Fyodor doesn't give a fuck about EP, and wishes Homerkles would use his proper name

Homerkles, you’re right about the superior pricing signals from the swap market. However, the three year swap rate is currently around 5.74% (cf. cash at 5.5%), so what does that tell you about rate expectations in the market?

Bring Back EP at LP
Bring Back EP at LP
2022 years ago

Firstly Fyodor educated people do not swear!

The swaps market is telling me that Super mac is on the money ( sorry couldn’t help it).
I am still a yield curve junkie so I think it is telling us monetary policy is still expansionary.

Chris Richardson is probably correct too in saying tax cuts in the next budget will lead to higher rates.

My guess is that Treasury is getting nervous about how the structural budget is deteriorating and being help up be the strong cyclical position.

Chris is worried about when commodity prices start falling, as they will, and the impact on the budget then.

It would be ironic if falling commodity prices coincided with rising interest rates leading to an economic slowdown.

of course the business cycle has been thrown out of the economics textbook at present.

I would be interested in Dr nick’s thoughts on that

Fyodor says you should go Homer

You’re absolutely fucking right, Homer. I must be unejumacated.

I think you’re wrong on the yield curve. The swaps curve is telling us 25bps is about the most we can expect in interest rate increases over the next three years. That is, we’re at (or past) the peak of the current tightening cycle.

Arguably, given a rising yield curve is normal, current mid-term yields suggest scope for material declines in interest rates.

Bring Back EP at LP
Bring Back EP at LP
2022 years ago

I was also going on a mate’s version of what he sadi the swaps market was and he had a longer dated version than you.

to be quite honest a 25 bp rise might be all that is needed to do ‘something’