Aahh, the good old days. When there were certain things you could rely on without fail. Things like having your newspaper delivered to your front door (or driveway or gutter or balcony – depending how good the paper-boy’s aim was); the milk being delivered at 6am and curdled by the time you picked it up at 7:30am (in the summer months); and finally, all mortgage interest rate rises or falls being determined by the Reserve Bank’s official cash rate.
All the above are no longer part of our daily lives. The media still holds its collective breath the first Tuesday of every month to see what the RBA has done with cash rates. Many economists and purveyors of financial services use it as a way of notifying their clients and potential clients of the most recent momentous decision by the RBA.
I have news for you. The RBA has not increased or reduced interest rates since it cut the cash rate by 0.25% on 3rd August 2016. So why are your rates going up (mostly)?
To answer that question, I have to return to a stroll down memory lane to the good ol’ days.
Until 1st July 1998 all prudential supervision of banks was performed by the RBA. Who also had the power to raise or cut rates. So, usually, the left hand knew what the right hand was doing. Then on that date, the Government of the day – after years/months of planning etc – formed the Australian Prudential Regulation Authority or APRA – not to be confused with the Australian Performing Rights Association. This new regulatory body took over the prudential supervision of banks, deposit taking institutions, insurers and other institutions.
So the RBA just focused on interest rates and taking the pulse of the economy.
The problem that has recently arisen is that APRA and the RBA have appeared to be pulling the economy in separate directions.
Firstly, the RBA has cut rates to historical lows to kick-start the economy which has languished at between 2-3% over the past 5 years or so. There appears to be consensus amongst economists that a growth rate of 3.3% is required to generate meaningful jobs (read wages) growth. The RBA’s low rates are meant to encourage businesses to borrow, spend and grow.
The problem has been that the only part of the economy that appeared to take off was housing.
In order to rein in this “bubble” (apologies for using this term – but it paints a picture), APRA has been quietly forcing the lenders to increase rates in areas that it thinks are high risk and should really have a rate increase. These areas include:
- Interest only loans to owner occupiers and investors alike. APRA regards these loans as particularly odious as banks have increased their rates on these by around 0.50%. If it doesn’t curb behavior as expected be prepared for further increases. If you have one of these loans you can switch to a principal and interest loan to avoid these increases. The long-term savings of not having an interest only loan is quite substantial (they obviously differ from loan to loan but your lender or broker should be able to perform that calculation within minutes). The key problem with these loans is obvious. You never reduce the principal – so you never repay your mortgage – ever.
- Investment loans for housing. Again, to curb the enthusiasm of investors in this sector banks have been forced (by APRA) to increase rates by around 0.50% or more to discourage investors.
- Other measures – such as lower LVR’s for investors, further restrictions for SMSF borrowers, income tests and more rigorous investigating, real world expense tests, stress test at 7.25% and controls on foreign incomes are just some of the measures to fine tune this segment.
So, has it worked? Well, it’s certainly turned off those investors that were borderline borrowers and the foreign investors that were borrowing and not paying cash. There’s still investors out there willing to borrow – and they can if they meet the ever-stringent criteria.
The one unfortunate side effect is that with all the tightening of banks’ servicing rules and the focus on real world expenses, first home buyers are being rejected. Watch this space as this group start being more vocal.
On the plus side many banks are cutting interest rates for owner occupied home loans that are not interest only.
To answer that question as to whether it’s worked or not, we’ll have to wait and see.
But if you’re reading headlines about what the RBA does with interest rates, just ignore them. They are now almost irrelevant to your housing loan – unless of course they go up…
This Week’s Top Policy Changes
As discussed last week, the topic of this week’s article is the main policy change this week. More banks have announced rate changes. Those that haven’t yet are using their lower rates to fill their boots with new clients. The unfortunate clients are not aware of the regulatory changes that all lenders will eventually have to comply with. They will often opt for the lowest rate only to be hit with a rate increase weeks/months into their new loan. Beware.
However – and this is a general statement – those loans that the banks are rejecting are being snapped up by unregulated lenders that are happy to take on borrowers without a perfect credit history. There’s a few of these and the best deals and circumstances vary depending on your financial requirements.
Given these deregulated lenders are funded by the banks, it kind of makes a mockery of the systemic changes that regulators are making.