Why are fixed rates so cheap?

[ali]

Hi all, I am a long-time reader of this forums and have learned a lot from the discussions. I have two properties (IP + PPOR) on variable rates, so I watch them closely.
All the experts suggest interest rates are on the way up, with at least one and probably more rises predicted for 2011. However, when you look at the bank fixed rates, many are on par with variable interest rates, even three years fixed rates.
Of course, historically borrowers have paid a type of insurance premium by fixing rates, and therefore they usually pay more than those on variable rates, in the short term (unless interest rates are on the way down).
Why are they so cheap at the mo? Does it suggest the banks don't think interest rates are going to go up much in the next 3 years?
Would appreciate any comments.

Cheers Ali

 

[charlieandkath]

G'day Ali, I would also like to know the same thing. Can anyone out there give us some answers? That would be great. Currently on 7.21 variable but can fix for 7.1 apparently for 3 years with CBA. This in my opinion would not be a bad move as to me I think this is quite cheap and would give some certainty.

 

[alexlee]

Banks don't offer fixed rates based on what they think rates will do in the future. They offer fixed rates based on the rate at which they can offload the fixed rate risk. If fixed rates have fallen, it means whoever is offering banks fixed rates (bond investors) are asking for lower rates than they were previously. There are a couple of possibilities: the bond buyers think rates will fall, there's a lot of money in the market chasing Australian mortgage bonds so the rate (the price) falls, or the market perceives Australian mortgages to be relatively lower risk than they used to (maybe because they've sold out of what they think are riskier bonds).

 

[marg4000]

As Alexlee said.

A fixed rate loan is a contract. So if the bank can borrow money at a lower interest rate at any one time then they will offer loans based on that rate. Once that amount of money is loaned, the next rate offered may be entirely different.

All based on the supply and demand of money.
Marg

 

[charlieandkath]

As Alexlee said.

A fixed rate loan is a contract. So if the bank can borrow money at a lower interest rate at any one time then they will offer loans based on that rate. Once that amount of money is loaned, the next rate offered may be entirely different.

All based on the supply and demand of money.
Marg

Two very general questions - so does this mean credit could be starting to loosen up? And then banks may start cutting variable rates?

 

[alexlee]

Two very general questions - so does this mean credit could be starting to loosen up? And then banks may start cutting variable rates?

The variable rate market is different because it's basically the govt bond rate + risk premium + bank profit. The variable rate may fall if the RBA cuts the official rate, or the risk premium (demanded by the market) falls.

Credit loosening (that is, banks more willing to lend) would be from two factors: banks having more money to lend (despite the money creation idea in fractional reserve banking, banks still need to borrow from someone else to lend to customers. It's not free), usually from greater interest fromm bond buyers, and/or banks willing to lower their serviceability calcs and LVR limits.

Variable rates and availability of credit are not directly related, though often the risk premium falls as more money is available to lend. However, on the rate side it's affected by the RBA rate, and on the availability side it's affected by bank attitudes. Due to the GFC, Australian banks are pickier in their lending than they used to be.

 

[Mooze]

Could also be that they've got money (liability) in, now they need to "purchase" assets (loans). I know at the moment it seems like the savings rate may be going up a touch compared to borrowings due to the way the money is flowing.

Could also just be marketing - I'd say that at 7.1 they're taking a loss leader position to try and get people in the door. Current market rates + risk premium + expenses would very likely be higher than what's on offer.

 

[alexlee]

Could also just be marketing - I'd say that at 7.1 they're taking a loss leader position to try and get people in the door. Current market rates + risk premium + expenses would very likely be higher than what's on offer.

I would doubt it. Banks are turning away residential loan business by tightening lending criteria. I don't see why they would have to make losses to get people in the door. I mean, where are people going? There's no sizable competition out there at the moment.

 

[luckyone]

Currently on 7.21 variable but can fix for 7.1 apparently for 3 years with CBA.

Where are you getting the 7.1 for 3 years figure from? According to their website it's 7.39% so even with the wealth package discount it's still 7.25%. Just curious in case I'm missing something.

http://www.commbank.com.au/personal/home-loans/fixed-rate/rates-fees/default.aspx

 

[imonmyway]

I fixed with St George last month for 3 years at 7.09%

 

[charlieandkath]

Where are you getting the 7.1 for 3 years figure from? According to their website it's 7.39% so even with the wealth package discount it's still 7.25%. Just curious in case I'm missing something.

http://www.commbank.com.au/personal/home-loans/fixed-rate/rates-fees/default.aspx

I started a thread called Interest Rate Check - January 2011. Search that as there is some relevant stuff in there about your post above. Cheers

 

[luckyone]

I started a thread called Interest Rate Check - January 2011. Search that as there is some relevant stuff in there about your post above. Cheers

Thanks heaps, I'll look that up.

 

[Rolf Latham]

Could also just be marketing - I'd say that at 7.1 they're taking a loss leader position to try and get people in the door. Current market rates + risk premium + expenses would very likely be higher than what's on offer.

meh.

My understanding is.........

Most fixed rates are based on large chunks long term bonds that folks like super funds provide.

The super fund wants a guaranteed cash income over x time with a fixed maturity date. That bond is priced as it is because there is some level of competition on the bond market.

A lender then "chops that bond up" adds their margin and on sells it

Relatively cheap at the moment because the bond issuers and the balance of the money market feels that VARIABLE wholesalerates wont go much above the average of the fixed bond

ta
rolf

ta
rolf

 

[ali]

Thanks for the information - very interesting reading. I had absolutely no idea it worked that way or that fixed and variable rates were somewhat independent of each other. Seems like a good time to fix, except my online loan provider has very uncompetitive fixed rates but great variable rates. It also has high exit fees!

Cheers Ali

 

[sash]

Fixing at 7.1% for 3 years is not wise at this point of the IR cycle.

I doubt we will see more than another 0.25-0.5% increase....I suspect by the year end we should see rates head back down. The economy is not moving at the same pace as last year.....with the flood levy and the impact of the flood on GDP will stay the hand of the RBA.

I am planning to fix...but only for 1 year. You can get 6.95% or less with the majors for 1 yr fixed rates.

G'day Ali, I would also like to know the same thing. Can anyone out there give us some answers? That would be great. Currently on 7.21 variable but can fix for 7.1 apparently for 3 years with CBA. This in my opinion would not be a bad move as to me I think this is quite cheap and would give some certainty.

 

[tom32]

I doubt we will see more than another 0.25-0.5% increase....I suspect by the year end we should see rates head back down. The economy is not moving at the same pace as last year.....with the flood levy and the impact of the flood on GDP will stay the hand of the RBA.

The trouble is GDP will be dropping because of capacity constraints not because of lower total demand in the economy. This is usually inflationary.

Dropping GDP does not always mean a deflationary outcome it depends whether it is dropping due to a loss of capacity or because of falling demand. A flood is in the former category and will likely even add to demand due to rebuilding apart from the loss of capacity around crops etc.

I expect the RBA will take the short term nature of a one off event into account to a degree but I am afraid the likes of a flood can only mean inflation, similar to a war or other capacity destroying demand pumping events even while GDP can slide prices do not.

These are distinctly different to the likes of demand falling due to a GFC, lack of credit availability etc where capacity remains but demand falls away causing a fall in GDP and deflationary outcomes because the capacity is still there.

 

[sash]

Yep....I agree.....but inflation is not likely to rear its head till about 2012-2013.

The other factor is wages....the cut in immgration is putting pressure on skilled people....add to this the number of baby boomers retiring and there could be hyperinflation down the track.

My thinking is get the relevant assets now....let inflation push up the values.....determine an exit strategy neare the peak...sell out....and pay down debt.

I suspect this cycle is likely to last 3-5 years.

The trouble is GDP will be dropping because of capacity constraints not because of lower total demand in the economy. This is usually inflationary.

Dropping GDP does not always mean a deflationary outcome it depends whether it is dropping due to a loss of capacity or because of falling demand. A flood is in the former category and will likely even add to demand due to rebuilding apart from the loss of capacity around crops etc.

I expect the RBA will take the short term nature of a one off event into account to a degree but I am afraid the likes of a flood can only mean inflation, similar to a war or other capacity destroying demand pumping events even while GDP can slide prices do not.

These are distinctly different to the likes of demand falling due to a GFC, lack of credit availability etc where capacity remains but demand falls away causing a fall in GDP and deflationary outcomes because the capacity is still there.

 

[The Fence]

Yep....I agree.....but inflation is not likely to rear its head till about 2012-2013.

The other factor is wages....the cut in immgration is putting pressure on skilled people....add to this the number of baby boomers retiring and there could be hyperinflation down the track.

My thinking is get the relevant assets now....let inflation push up the values.....determine an exit strategy neare the peak...sell out....and pay down debt.

I suspect this cycle is likely to last 3-5 years.

LOL....so much for folks who say values will be dropping 40-50% (or even 10%)....ha ha haaa...!
Love it Sash...

Never fixed yet and never will.....I'm also of the belief that rates will be lower or same in another 12 months time..not higher.
And still they are cheap anyhow....

 

[Marty McDonald]

I think it is an excellent time to fix but like always only if you don't think you could afford a 1-2% increase in rates. From my experience 8 years mortgage broker and 7 years interest rate futures trader I think you can't have any way of knowing what is around the corner and while the market is never wrong on a day to day basis it can be very misguided over the medium term.

 

[charlieandkath]

I think it is an excellent time to fix but like always only if you don't think you could afford a 1-2% increase in rates. From my experience 8 years mortgage broker and 7 years interest rate futures trader I think you can't have any way of knowing what is around the corner and while the market is never wrong on a day to day basis it can be very misguided over the medium term.

I'm tending to agree more with you Marty. Rates to me are cheap now so why not lock in and take out that uncertainty. I will be looking at doing this pretty soon and have already started making enquiries.