Mortgage rates are a hot topic in Australia at the moment. Two issues are at the forefront of any discussion on mortgage rates today.
Firstly there is general concern amongst borrowers in Australia that mortgage rates may further increase over the short term. The Reserve Bank has increased the Official Cash Rate (OCR) a number of times this year and it is currently sitting at 6.50% p.a. These increases immediately impact on the cost of funds for lending institutions, both bank and non-bank, and as a result mortgage rates have also increased, with the banks standard variable rate now at 8.32% p.a. and the non-bank lenders generally in the market with mortgage rates around 7.75% p.a. By increasing the OCR the Reserve Bank is well aware that mortgage rates will follow suit. Under its charter, the Reserve Bank is responsible for formulating and implementing monetary policy that will contribute to:
(a) the stability of the currency of Australia;
(b) the maintenance of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia.
These objectives have found practical expression in a target for consumer price inflation, of 2-3 per cent per annum. Controlling inflation preserves the value of money and is the main way in which monetary policy can help to form a sound basis for long-term growth in the economy.
So, how does an increase in the OCR and mortgage rates generally help achieve these inflation targets? As the mortgage rates increase across Australia, borrowers have less surplus cash to spend, there is less demand for consumables, businesses have less money to invest and as a result the economy is slowed down and the inflation rate is held in check. If the economy is too slow the Reserve bank can effectively reduce mortgage rates (by reducing the OCR) and thereby provide borrowers with more surplus funds. This increases demand for consumables and one sees greater economic activity.
It is ironical that because in Australia we are enjoying strong economic growth and have employment at an all time high we end up finding our mortgage rates increasing. If we were to save more rather than spend and borrow, inflation would not be increasing at the level it is and mortgage rates would remain steady.
But would they? This brings me to the second issue which has had a significant impact on mortgage rates and has made headlines in newspapers in Australia over the past few months. In the past mortgage rates in Australia have been pretty much domestically driven (i.e. by the Reserve Bank) but more recently we have seen mortgage rates influenced by problems occurring in international financial markets. The main culprit is the United States where there have been unprecedented mortgage defaults which have frightened off would be global lenders and investors in mortgage securities. Even though mortgage rates in Australia remain relatively low and defaults here are not a significant problem (in other words they remain a sound investment), the US default crisis has scared off potential investors. As a result mortgages are no longer flavour of the month and those that are still prepared invest are seeking a higher rate of return. Consequently the cost of funds world wide increases for debt securities and mortgage rates across the world increase as result. As noted earlier the banks current standard mortgage rates sit at 8.32% p.a. variable which is up to .50% more than the non bank mortgage rates of 7.75% p.a. Because the banks’ mortgage rates were considerably higher than the non-banks before the impact of the US situation, to date they have been able to hold their rates. The non-bank lenders, who have historically priced their mortgage rates below the banks, have had to move their mortgage rates sooner because they simply don’t have the profit margins, the “fat” in their pricing, which most banks enjoy.
The banks are endeavouring to gain market share with claims that they are holding their mortgage rates (8.32% p.a.) but hopefully borrowers will recognise that the mortgage rates of the non-bank mortgage manager lenders remain competitive. They might also want to consider where mortgage rates would be without the mortgage manager competing with the banks for their business. Prior to the non- bank mortgage manager entering the market, the banks’ mortgage rates contained profit margins of up to 3 % p.a. Back in the 1990s the non-bank lender was able to enter the market and compete aggressively for business because they were not trying to maximise profit at the expense of borrowers but rather offered mortgage rates that were well below the major banks. The banks were initially quite arrogant, holding their mortgage rates and profit margins, thinking that lower mortgage rates would not be enough to woo borrowers. Little did they realise that the non-bank sector not only offered lower mortgage rates but also professional and friendly service. It took around 3 years before the banks finally reduced their margins and offered mortgage rates that were somewhat more competitive.
The next few months will determine whether the US mortgage crisis will be a short term problem for mortgage rates or whether the meltdown in America will have a long term impact on mortgage rates in Australia. In the meantime keep an eye on mortgage rates across the market, sit tight because no matter which lender you are with, mortgage rates over the next few months will be a little unpredictable but inevitably are likely to settle down again.