To fix or not to fix, that is the housing loan question

One of the more interesting market responses to the Reserve Bank’s decision to cut the official cash rate to just 0.1% is the growing rift between fixed and floating home loan rates.

Fixed rates over four years have now fallen decisively below 2% – a staggeringly low rate that has never before been seen in Australia.

At the same time as the big four banks were trumpeting their new, low fixed rate loans, there was deathly silence about when the RBA cut would mean for existing borrowers on floating rate loans.

Some of the smaller institutions cut their floating rates but there was no announcement from the big four with their massive loan books now groaning with customers paying rates well above what they could get if they refinanced, or particularly if they switched to a fixed rate loan.

Instead there was the usual welter of instructions from financial planners that people should do their comparison research and “prepare to switch’’ and then threaten to walk out on their bank to hopefully “earn” a more competitive offer – either from their existing lender or a new one.

Given the size of upfront expenses on a home loan and the reluctance of the average bank customer to try out their negotiating skills in a high stakes game of poker with their bank, it was hardly a novel or risk-free suggestion.

There may be some extra sugar to be hoovered up by going into battle but nowhere near as much as there is by moving to a fixed rate loan.

Is this as low as rates can go?

Traditionally, most financial planners have been very cautious about fixed rate loans, arguing that they could be dangerous because customers are locked into them by hefty break fees while rates could fall further, leaving the customer with a bad deal they can’t get out of.

That is literally now no longer the case with RBA Governor Dr Phillip Lowe making it clear that official rates won’t be going negative but are unlikely to rise for a long time to come.

As the RBA Board said in their decision “The Board is not contemplating a further reduction in interest rates. With the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances at zero, interest rates have been lowered as far as it makes sense to do so in the current environment.

“The Board considers that there is little to be gained from short-term interest rates moving into negative territory and continues to view a negative policy rate as extraordinarily unlikely.

“The Board has committed not to increase the cash rate target until actual inflation is sustainably within the target range of 2–3%. This will require a period of strong employment growth and a return to a tight labour market.’’

That’s as clear a forecast as you are ever likely to get from a central bank and begs the question, why wouldn’t the average customer simply “lock it in, Eddie’’ and refinance with a fixed rate loan – assuming the numbers made sense after taking all costs into account.

Not much downside left

Even if the RBA is wrong and is forced into setting a negative cash rate, the downside difference is likely to be small – nothing like those customers who prematurely locked-in at 7% or even 4%, only to see rates plummet still further.

The simple answer is that a lot of people will be snapping up those fixed loans, which the banks will still be making a tidy profit on given that they have already taken advantage of $83 billion of ultra-cheap money from the RBA, with another $104 billion still available from this facility at the cash rate of just 0.1%.

Get ready for the fixed rate stampede

National Australia Bank chief executive Ross McEwan let the cat out of the bag when he admitted that the bank was expecting a rush of refinancing applications, with fixed loans potentially rising as high as 30% of their total loan book.

“The reality is that this market is moving more toward fixed rates for certainty, it was about 10% of the (NAB) book I think you’ll see it quite quickly getting to 30% … we are seeing that in the (new mortgage) flows,” Mr McEwan told The Australian.

If it comes to pass that is a serious amount of refinancing activity and it seems the banks are all preparing for it – offering the juiciest just sub-2% fixed loans they can and hanging on to the higher floating loan rates for as long as they can.

Traditionally Australian home loans are predominantly floating rate loans, with features such as offset accounts and the ability to refinance at any time trumping the “locked in’’ nature of fixed loans.

However, with the big Australian banks now pushing fixed rate loans strongly and rates scraping the bottom of the barrel, that could all be about to change amid a welter of loan refinancing.