Why Are Home Loan Variable Rate Higher than Fixed Right Now?

witsa on 22/09/2020 - 22:32

Looking at re-financing my loan for investment property. Seems the fixed rates are about 2.49-2.69% but the variable rates are around 3%.

That's around 0.5% difference.

Normally banks adjust the rates that'll give them the maximum profit, and if there's one thing they're good at, it's making money.

So what's the deal with this? Even if banks are expecting interest rates to go lower, how much lower can they go? The cash rate is 0.25% right now.

If you fix for 2 years, even if it fell to 0.5% to -0.25% within the first year and then another 0.5% to -0.75% at the end of your second year (and assuming the banks pass on the rate drop) for you to be worst off.

Is this what the banks are expecting to happen?

Financial Home Loan Loan

Comments

  • MadgeH on 22/09/2020 - 22:53

    Strange times indeed..
    Fixed rates have been lower than variable rates for a while but the gap hasn't been this big.
    I'm of the same thinking, it will take a lot for you to be worse off on a fixed rate vs variable (without considering of course if you decide to sell your property during the fixed term etc.)
    I've watched a few webinars held by the banks (I'm in the industry as a broker) and the general consensus is it is highly unlikely RBA rates will go into negative territory so I am actually in the process of refinancing my own loans and fixing part of them to take advantage of the low rates.
    I'm thinking the cost of funding on fixed rate loans is pretty cheap so the banks are able to offer some pretty good rates on those loans. Competition is also another thing driving demand for fixed rates, the banks want you to stay with them for longer.

    • IVI on 22/09/2020 - 23:15
      -5

      Good. You reminded me of the obvious (but oft forgotten):

      You can do "One each Way"
      (some in variable + some in fixed)

      Now, how much extra does doing that cost
      (not for an insider/broker, for for reg. Joe's)?

      You're also able to take the best deals from
      2 (or more) lenders…

      Thanks for the reminder…

  • IVI on 22/09/2020 - 23:10
    -5

    Re "How much lower can Interest go?"

    Didn't I read, that Japan(?) has or had, for a time,
    slightly negative interest rates, suggesting that
    you could earn a few yen by borrowing…

    That's kind of a gov't or bank Subsidy…

    /Begin Rant

    (Hey, if such a scheme helps a business to
    grow, hire more folks, & incr. profit, over time,
    it's Not such a bad thing, even if it =seems=
    counterintuitive, from our (limited) perspec-
    tives.

    It's good to hop out of your own system,
    now & then, to expand your ideas of the
    possible & what's good for people &/or
    business &/or "the Economy"…

    Eg, view docu: "Where to Invade Next?"
    & see how OTHER PEOPLE think/Live.

    (Today, we viewed "Botany of Desire" a
    docu on Apples, Tulips, Canibis & Potatos

    Michael Pollan, et al. covered, eg,
    down-sides of monoculture, in growing
    foods; "tulip-madness" (boom+bang) in
    NL = now one of the "Happy Countries"

    I learned a lot about each of its 4 prod-
    ucts, historically & as others in the
    World see/saw 'em.

    …I HIGHLY recommend this docu)

    Eg, compare Health, Work-Injuries/-Deaths
    in Energy industry, eg, NUCLEAR France
    vs COAL Qld (where coalminers were
    still getting Black Lung disease), NSW &
    Vic. where burning of TOXIC COAL has
    to be adversely affecting folks' Health.

    All because Gen'l de Gaulle "forced" his
    country to invest in NUCLEAR in a big,
    clever, gov't-run way…

    While AU stubbornly BANS Nuclear
    Energy & our COAL-MONGERING PM
    has to take a lump of Coal into Parlia-
    ment to "show other MPs it's safe"

    "Past is Prologue"

    France is / was a truly Smart Country

    Australia has a long way to go in that
    direction, & MONGERING COAL is
    - IMO - holding us & our kids back.

    "Lift AU's 1999 NUCLER ENERGY Ban!"

    /End Rant ;~)

  • netjock on 22/09/2020 - 23:59
    +1

    If you enter into fixed rate the bank offsets the risk by sourcing funds (issuing debt) to cover. 2 - 3 year bond rates are low right now. RBA playing with the yield curve.

  • dcep on 23/09/2020 - 01:02

    banks are not expecting lower interest rates, it's just that RBA printed a lot via QE, so might as well fight for HL market share with these cheap monies

  • p1 ama on 23/09/2020 - 01:19
    +7

    I used to do macroeconomic modelling with interest rates and inflation!

    1) No, nominal rates probably will not continue to fall, but real rates will because of inflation. Real rates are already negative right now.

    2) With fixed rate loans, you generally cannot pay them off early, whereas with variable rate loans, you can. Therefore, if there are two individuals, one who has fixed their loan and one who left it at variable, it's almost certain that the one who left it at variable will have paid off more over the two years. Obviously it's in his interest to do so if he believes rates are going to go up. Thus, when rates eventually do increase, the bank will rake more interest from the one who fixed their loan as they now have a larger outstanding balance. Thus, it makes perfect sense for the bank to entice people to fix their loans so that they can't pay them off early in a very low-rate period.

    In other words, it's a very small price to pay to fix not just the rates, but also the loan outstanding in 2 years as well (from the bank's perspective).

    Basically you have to think about duration (https://en.wikipedia.org/wiki/Bond_duration) as well as rates.

    In general, fixing your loans is betting against the bank. I have friends who I went to university with all of whom have PhDs in various fields such as computer science, mathematics, economics…etc. working at the major banks. I'm not saying everyone who fixes their loan will lose, but know who you are betting against.

    • Neoika on 23/09/2020 - 07:09
      +1

      There is another option to balance: Spilt Loan.

    • witsa on 23/09/2020 - 10:23

      great - someone with some academic background who can explain!

      "I'm not saying everyone who fixes their loan will lose, but know who you are betting against."

      Sure I get and agree with that, but what I'm trying to understand is the logic.

      "No, nominal rates probably will not continue to fall, but real rates will because of inflation. Real rates are already negative right now."

      You're saying real rates will fall further as inflation increases. Why would that make banks want you to fix your loan? Wouldn't they instead be wanting you to go variable as inflation raises, their operating costs increase, but with a fixed loan, they're not going to squeeze any more out of you.

      " With fixed rate loans, you generally cannot pay them off early, whereas with variable rate loans, you can"

      Firstly, someone already mentioned anyone with the capacity to pay back simply gets a split loan. The other thing is most fixed loans let you put in 10k-20k per year anyway. But ignoring that, does this really make sense from the bank's perspective?

      Those who can pay a loan early are the best customers to lend to. They're the least likely to default as they're making beyond their living costs and they have a buffer. If that was the reason to make fixed rate lower, aren't they effectively discouraging safer loans over loans with higher chance of default?

      • Ughhh on 23/09/2020 - 11:49

        Those who can pay a loan early are the best customers to lend to

        I would think the ideal customers would be ones who can't pay off the loan early, but is making it through and not behind in repayments. Theres no interest for a bank to loan to you if they can't make much money off you, ie you not paying much interest. It's like lending someone $1000 just to earn 20c.

        • witsa on 23/09/2020 - 13:25

          sure, that's the ideal case for the bank for a customer to pay everything off at exactly the rate of repayment. But that person is only identified after the fact. When they make the loan to this person they would only know that this person can only just meet their repayments and would be considered a higher risk of default.

          It's like saying the ideal customer for an insurance company is someone who has to pay high premium rates cause they're identified as a high risk but who doesn't crash their car. That's true but there's no way for the insurance company to distinguish that from the person who pays the higher premium because they are more likely to crash.

          Also, if you pay off the loan quicker, the bank doesn't lose money. It just means they have their money back quicker and they can lend it to someone else. Plus, those who can pay off their loan quicker are likely to be in a higher socio-economic class which means the loans will be bigger and they're likely to take out more loans for investment properties after they've finished off the PPOR loan.

          • Ughhh on 23/09/2020 - 13:56

            @witsa:

            But that person is only identified after the fact.

            There's a reason why they require proof of income, assets and bank statements. Banks have algorithms to determine the risk and how much to lend you.

            The purpose of the bank lending money is to make money. Sure they're not losing money, but they're not making money, that money they lent you could have gone to someone who would have yielded them more profits. You paying it early, means they're back to square one.

            These guys explain it quite well
            https://economics.stackexchange.com/questions/6835/why-do-le…

            • witsa on 23/09/2020 - 15:23

              @Ughhh: Thanks.

              The first answer on that post makes sense

  • AlanJ on 23/09/2020 - 08:23
    +1

    There was a time when fixed rates were always higher than variable, because the most important thing for the bank was to cushion itself against sudden rate rises. Back in those days you could get 10-year fixed rates (I don't think these are available any more); that "cushion", therefore, had to be applicable for the foreseeable future…. so you paid dearly for the security of sleeping easy. Nowadays, most fixed-rate offers are for as short as two or three years, and it's not hard for the banks to predict that far ahead; even if rates don't fall further, or even rise slightly, it's no big deal. And there is another benefit for the banks with encouraging a fixed rate: nowadays. economists are always saying "if your bank won't give you a better deal, walk out!" Changing banks on a whim is much more common now than a few years ago, and it the bank loses more customers than it gains, well, that's not such a great outcome for the bank; shareholders don't like to hear that! So, fixing a loan, making it expensive for you to get up and walk, is a good way for the banks to sleep easy!
    .

  • SydBoy on 23/09/2020 - 08:27
    -1

    fixed rates are good when use them for principal place of resident and you are sure that you will live in it for the duration of fixed term loan and not intending to sell. fixed rate loans not good if you have to break the loan.

  • onetwothreefour on 23/09/2020 - 08:42

    I took the risk and fixed mine at 2.22% a couple months ago. I'm currently only paying approx $200 per month in interest and that's dropping every month as I make extra repayments every month and top up my offset account when I can so I figured even if the rates do drop lower than what they are now then I won't be losing out too much.

    • Yazanm on 24/09/2020 - 13:36

      May I know with which bank is your Mortgage ? I rarely came across a bank offering an offset account with a fixed home loan. Thanks

  • ChunkyToast on 23/09/2020 - 09:46
    -1

    The RBA Deputy Governor gave a speech yesterday about the 4 things they could do to bolster economy.

    1) Print more money + Buy more Gov Bonds
    2) Intervene in FX Markets and force dollar down or try cut it rising
    3) Cut interest rates more (e.g. to like 0.1%)
    4) or take interest rates negative

    I don't know about the likelihood of the above but the above was not directly ruled out at all. The banks have smart people and computers working to predict 3) and 4) and then offer you a product that have a higher probability of making money for them, in the case of lower fixed rates vs higher fixed rates - assuming they think the rates could actually go lower?.

  • El-Rhi on 03/10/2020 - 07:40
    +1

    Banks can access cheaper fixed rate funding compared to variable rate funding, hence the difference for borrowers. This is mostly explained by the RBA term funding facility (TFF), which gives banks access to three year fixed funding at 0.25%, and the RBAs management of the longer term yield curve, through its bond buying program.

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