Author Topic: 5 year fixed mortgage interest rate down to 5% in Australia....  (Read 11217 times)

Rodstar

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I'm curious whether any Australians (like myself) are tempted to fix their mortgage at 5% for 5 years. 

The big banks have just slashed their 5 year rate.....tempting but....

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #1 on: July 31, 2014, 08:13:33 AM »
Nope, not tempted. I view fixed rates as a gamble on the future: who's going to pick what happens to interest rates better: me or the bank? What it does say to me is that the banks think variable rates will drop, and probably below 5% for the next 5 years.  The only time I think it would be worth it was if one was highly leveraged and getting nervous that any increase in interest could not be serviced.

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #2 on: August 01, 2014, 11:02:58 AM »
I'm about to get a 30yr fixed rate mortgage at 4.1%, in USA.

the risk that rates go down is offset by being able to refinance with no fees. If the rate goes down significantly,  you replace it with a new even lower rate.

arebelspy

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #3 on: August 26, 2014, 08:12:01 AM »
Nope, not tempted. I view fixed rates as a gamble on the future: who's going to pick what happens to interest rates better: me or the bank?

Or think of it as a way to lock in costs.

And then if they drop, lock in again.

When they go up, you're happy you locked in.

Since you can refi when they go down, but the banks can't call it when it goes up, that gives you an advantage. Why would you give that up?

Something to think about.  ;)
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happy

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #4 on: August 26, 2014, 04:09:00 PM »
My understanding is that in Australia once takes up a fixed rate for a set period e.g. 3 years or 5 years, and that is a locked-in contract i.e. you can't refinance it within the period that is fixed.
 
As always this community challenges my notions, and I will check out that my understanding is correct. Maybe some other Aussies can comment?

steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #5 on: August 26, 2014, 05:57:14 PM »
My understanding is that in Australia once takes up a fixed rate for a set period e.g. 3 years or 5 years, and that is a locked-in contract i.e. you can't refinance it within the period that is fixed.
 
As always this community challenges my notions, and I will check out that my understanding is correct. Maybe some other Aussies can comment?

This is basically correct and I'm surprised it is different in the US because it makes no sense otherwise. Looking in the interest rate means that the bank locks in their funding as well. If you can simply re-fix your loan in your favor whenever it suits you it seems a little weird.

The only reason it is basically correct is that you can re-fix your loan at any point with an associated fee which balances out the profit/loss the bank would have made. So if you have a fixed rate of say 3% and interest rates rise you could pre-pay the interest however the bank would pay you.

I hope to pay my mortgage off within 2 years so fixing it is not an option for me personally.

briandougherty

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #6 on: August 26, 2014, 06:02:24 PM »
This is basically correct and I'm surprised it is different in the US because it makes no sense otherwise. Looking in the interest rate means that the bank locks in their funding as well. If you can simply re-fix your loan in your favor whenever it suits you it seems a little weird.

The only reason it is basically correct is that you can re-fix your loan at any point with an associated fee which balances out the profit/loss the bank would have made. So if you have a fixed rate of say 3% and interest rates rise you could pre-pay the interest however the bank would pay you.

It's not "refixing" it's refinancing the whole thing.  So Bank A gives me $200k at 5% and two years later Bank B will give me $150k at 4% then I just borrow the money from Bank B and that pays off Bank A.  Bank A really has no say.  There are normal loan closing costs but they go to Bank B.  Obviously in the U.S. this is all backed up by strong pro-borrowing, pro-homeownership policies.

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #7 on: August 26, 2014, 09:17:35 PM »
This is basically correct and I'm surprised it is different in the US because it makes no sense otherwise. Looking in the interest rate means that the bank locks in their funding as well. If you can simply re-fix your loan in your favor whenever it suits you it seems a little weird.

The only reason it is basically correct is that you can re-fix your loan at any point with an associated fee which balances out the profit/loss the bank would have made. So if you have a fixed rate of say 3% and interest rates rise you could pre-pay the interest however the bank would pay you.

It's not "refixing" it's refinancing the whole thing.  So Bank A gives me $200k at 5% and two years later Bank B will give me $150k at 4% then I just borrow the money from Bank B and that pays off Bank A.  Bank A really has no say.  There are normal loan closing costs but they go to Bank B.  Obviously in the U.S. this is all backed up by strong pro-borrowing, pro-homeownership policies.

I'm not sure if it's still the same, but in Aus previously if you had a fixed loan and broke the contract early to refinance into another loan (fixed or variable) you had to pay a penalty. And the penalty was the difference between what your new lower rate was and what your old fixed rate would have been. So if you refinanced to save $100 a month and had 2 years left on your fixed mortgage, the penalty the bank was legally allowed to charge was $2,400, effectively negating any benefit to refinancing.

Things may have changed. But that's how it used to be.

superannuationfreak

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #8 on: August 26, 2014, 09:33:18 PM »
Sometimes it can be worth breaking.  The early repayment costs of fixed loans in Australia are based on the difference in bank funding costs rather than the interest rate you pay (obviously correlated but not the same).  Last time I fixed it was worth breaking but only because my circumstances changed unexpectedly (and it was only a small proportion of my loan - the cost ended up less than the other bank rebated me to refinance with them).

Right now if I still had a substantial mortgage I think it would be worth fixing unless there's a reasonable probability of life changes in that time that might change your lending needs.  For example, if there's the possibility of moving overseas, or wanting to upgrade to a larger place (shock horror!), or even just having the ability to pay off the mortgage much faster than you can now (many banks limit how much extra you can pay off a fixed loan each year).  If it's likely for the next X years that such large changes won't occur then fixing for up to X years while interest rates are this low (by modern Australian standards) can make sense.  If changes are likely before the X years are up then it can be a costly exercise.
« Last Edit: August 26, 2014, 09:55:28 PM by superannuationfreak »

arebelspy

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #9 on: August 26, 2014, 09:36:43 PM »
Yeah, the US pretty much got rid of prepayment penalties.  Surprised to hear they're still a thing over there.
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steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #10 on: August 26, 2014, 10:53:31 PM »
This is basically correct and I'm surprised it is different in the US because it makes no sense otherwise. Looking in the interest rate means that the bank locks in their funding as well. If you can simply re-fix your loan in your favor whenever it suits you it seems a little weird.

The only reason it is basically correct is that you can re-fix your loan at any point with an associated fee which balances out the profit/loss the bank would have made. So if you have a fixed rate of say 3% and interest rates rise you could pre-pay the interest however the bank would pay you.

It's not "refixing" it's refinancing the whole thing.  So Bank A gives me $200k at 5% and two years later Bank B will give me $150k at 4% then I just borrow the money from Bank B and that pays off Bank A.  Bank A really has no say.  There are normal loan closing costs but they go to Bank B.  Obviously in the U.S. this is all backed up by strong pro-borrowing, pro-homeownership policies.

Its the same thing to me - you could do it between banks or within the same bank. The point being that there is no prepayment penalty which makes absolutely no sense.

Its like hedging an interest rate but if it goes against you there is no penalty. Honestly it makes no sense. Its bizarre.

Yeah, the US pretty much got rid of prepayment penalties.  Surprised to hear they're still a thing over there.

Maybe we shouldn't call it a prepayment penalty. There are no prepayment penalties in Australia. When you fix your mortgage you are basically hedging the interest rate so that if it goes up you get locked in with the lower rate. If it goes down then you have picked the market incorrectly. All that happens in Australia is that you are made to pay out the interest differential which could mean the bank paying you money if the rates have risen.

Are you sure that this doesn't exist in the US ? If it doesn't then every time the rates go down you could just re-fix the interest rate at a lower rate which means that you have a hedge against rates going up and no penalty if they go down. Its not logical.

The early repayment costs of fixed loans in Australia are based on the difference in bank funding costs years are up then it can be a costly exercise.

Which makes sense from a financial perspective.
« Last Edit: August 26, 2014, 11:04:43 PM by steveo »

arebelspy

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #11 on: August 27, 2014, 08:10:28 AM »
Yeah, the US pretty much got rid of prepayment penalties.  Surprised to hear they're still a thing over there.

Maybe we shouldn't call it a prepayment penalty. There are no prepayment penalties in Australia. When you fix your mortgage you are basically hedging the interest rate so that if it goes up you get locked in with the lower rate. If it goes down then you have picked the market incorrectly. All that happens in Australia is that you are made to pay out the interest differential

Yeah, that's a prepayment penalty.

If you pay off the whole loan, in cash, do you owe that loan differential?  If not, then how do they know if you're paying off the loan with refinanced money?  If yes, then it's a prepayment penalty.

Yeah, the US pretty much got rid of prepayment penalties.  Surprised to hear they're still a thing over there.
All that happens in Australia is that you are made to pay out the interest differential which could mean the bank paying you money if the rates have risen.

Huh?  Explain this.

Are you sure that this doesn't exist in the US ? If it doesn't then every time the rates go down you could just re-fix the interest rate at a lower rate which means that you have a hedge against rates going up and no penalty if they go down. Its not logical.

Right, that's exactly what you do.

The early repayment costs of fixed loans in Australia are based on the difference in bank funding costs years are up then it can be a costly exercise.

Which makes sense from a financial perspective.

Well you still pay the origination fees, loan costs, etc., so it's not like the banks are really hurting here.
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Primm

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #12 on: August 27, 2014, 11:04:42 AM »

If you pay off the whole loan, in cash, do you owe that loan differential?  If not, then how do they know if you're paying off the loan with refinanced money?  If yes, then it's a prepayment penalty.

Yes you do. So it's a prepayment penalty.

« Last Edit: August 27, 2014, 11:06:16 AM by Primm »

steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #13 on: August 27, 2014, 03:20:59 PM »
You can call it whatever you want to call it however to me it makes perfect sense that there needs to be an interest adjustment. It actually seems to me really really dumb if there is no interest adjustment and it makes no sense and shouldn't occur in a capitalist economy.

I suggest you think of this as a hedge on interest rates which is exactly what a fixed rate is and its better to think of it as an adjustment because the Banks could pay you money.

If you hedge something you are basically making a play to minimize your risk but at the same time you are in some ways betting on the movement of whatever you are hedging against. The banks can do this as well because they hedge their own exposure. Maybe a better way to look at this is for instance in the foreign currency markets. Say that you export goods from Australia to the US and you trade in US dollars. You are concerned that the US dollar will go down in value and buy less Australian dollars in the future so you hedge the dollar at the current rate for the next 6 months. Now if the US dollar goes up you have actually lost the additional Australian dollars that you would have had if you didn't hedge the dollar. If the US dollar goes down you are not exposed to this movement and you are actually profiting from the differential between the price when you hedged and the current price. This is exactly the same as the interest rates moving either for you or against you.

So taking a step back into the home loan market:-

1. You fix rates at say 5% and interest rates move to 10%. You are gaining a benefit of 5% whereas the Bank could be lending that money out at an additional 5%. In this case the bank would pay you an interest differential if you paid the loan out early as they are losing on this transaction.
2. You fix rates at say 10% and interest rates move to 5%. The bank is gaining a benefit of 5% whereas you are losing that 5%. In this case you would pay the bank the interest differential if you paid the loan out early as they want you to continue paying above market rate as at the point of making the transaction this was the agreement.

I hope that makes sense and shows why in a capitalist system there has to be interest adjustments on fix loans. If there is no interest adjustment then you can hedge with no downside to that hedge.

If you could do this in the foreign currency markets we would all be multi-billionaires. All you do is hedge say $100,000,000 against the US dollar going down via say taking a 6 month forward contract at the current rate say you purchase AUD at .98c = $1USD. You now own $100,000,000 $AUD at that rate which you can repurchase in 6 months time. Now if the US dollar drops to .90 then what you do is pocket the difference of .98 - .9 on $100,000,000. I think that this would be like $8 million dollars. Now if the rate goes against you the same event happens in reverse. If there is no interest adjustment in the US you are basically just being open to the upside event occurring. If we take that to the foreign currency market all you do is take a position and if it goes your way you are rich. If it goes against you no problem you just re-adjust to current market conditions with no loss.

Sorry to the OP for being so off-topic. My personal opinion is never to fix your loan because typically the bank will only give you a limited time period of being able to fix the loan and during that time you can only make limited additional repayments. We like to pay as much as possible into our mortgage and get rid of it as quickly as possible. In saying that if you have a lot of debt this is a good way to minimize your risk for the fixed period.
« Last Edit: August 27, 2014, 03:27:59 PM by steveo »

arebelspy

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #14 on: August 27, 2014, 04:11:06 PM »
It's okay if it seems dumb to you.  That's how it is.

There are frictional costs involved with paying off a loan, and taking out a new one.  But yes, refinancing to lock in a lower rate without prepayment penalty is a great thing for borrowers.
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marty998

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #15 on: August 27, 2014, 04:30:03 PM »
Banks hedge every single loan. When you borrow a fixed rate loan from the bank here, your bank will match it off using funding that it has in turn borrowed with a fixed interest rate (from depositors or wholesale credit markets). The bank therefore locks in its Net Interest Margin (NIM) and limits its interest rate risk.

The bank will also use Interest Rate Swaps (IRS) to convert fixed to variable and variable to fixed on its own balance sheet to match off interest rates and duration profiles of all of its loans.

If you decide to break that fixed loan, the bank has to break its fixed interest funding or IRS. The bank charges you a break fee to cover the loss in breaking its own funding arrangements. This is one penalty that is a loss mitigator, not a profit generator for the banks.

If the fee wasn't charged, a bank can go insolvent quite quickly depending on the borrowing profiles of its customers.

marty998

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #16 on: August 27, 2014, 04:36:33 PM »
Oh by the way, banks are not offering fixed rates of 5% because that's where they think interest rates will be for 5 years.

They are doing it because they are able to raise 5 year funding at a rate that allows them to make a 5 year loan that is profitable at 5%.

It's not really a question of betting on rates for the bank, the bank will always win by fixing its NIM (see above). For the ordinary borrower it comes down to personal preference. Certainty of rate vs flexibility of prepaying & variable.

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #17 on: August 27, 2014, 06:54:58 PM »
You can call it whatever you want to call it however to me it makes perfect sense that there needs to be an interest adjustment. It actually seems to me really really dumb if there is no interest adjustment and it makes no sense and shouldn't occur in a capitalist economy.

My understanding is most of the rest of the world behaves as you expect. The US is kind of an exception due to heavy(ier) government involvement/backing of housing loans for historical/political/social reasons
http://www.marketplace.org/topics/sustainability/who-thought-30-year-mortgages-were-good-thing

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #18 on: August 27, 2014, 06:56:50 PM »
It's okay if it seems dumb to you.  That's how it is.

There are frictional costs involved with paying off a loan, and taking out a new one.  But yes, refinancing to lock in a lower rate without prepayment penalty is a great thing for borrowers.

I cant help but suggest that asymmetric fixes of interest rates (upside all to customer), combined with non recourse loans (where an underwater owner can walk away) are two of the reasons why the US banking system had such a meltdown during the GFC.  These practices seem to massively shift risk from the property owner/speculator to the lending institution. 

While I have my gripes with the Australian banking system, I suspect that some of these differences help keep the Australian banking system much more stable than the US system.

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #19 on: August 27, 2014, 07:58:37 PM »
It's okay if it seems dumb to you.  That's how it is.

There are frictional costs involved with paying off a loan, and taking out a new one.  But yes, refinancing to lock in a lower rate without prepayment penalty is a great thing for borrowers.

I cant help but suggest that asymmetric fixes of interest rates (upside all to customer), combined with non recourse loans (where an underwater owner can walk away) are two of the reasons why the US banking system had such a meltdown during the GFC.  These practices seem to massively shift risk from the property owner/speculator to the lending institution. 

While I have my gripes with the Australian banking system, I suspect that some of these differences help keep the Australian banking system much more stable than the US system.

From my understanding, the subprime crisis pretty much had nothing to do with that, (and, in fact, rates weren't necessarily that low at the time). 
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steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #20 on: August 27, 2014, 08:33:15 PM »
You can call it whatever you want to call it however to me it makes perfect sense that there needs to be an interest adjustment. It actually seems to me really really dumb if there is no interest adjustment and it makes no sense and shouldn't occur in a capitalist economy.

My understanding is most of the rest of the world behaves as you expect. The US is kind of an exception due to heavy(ier) government involvement/backing of housing loans for historical/political/social reasons
http://www.marketplace.org/topics/sustainability/who-thought-30-year-mortgages-were-good-thing

Which makes sense. I view the US market as obviously not being efficient. There has to be a cost or risk that is being hidden via following the US approach. To me that is a concern and shows poor banking practices.

From my understanding, the subprime crisis pretty much had nothing to do with that, (and, in fact, rates weren't necessarily that low at the time).

Maybe the GFC wasn't specifically related to this issue but there is obviously a risk and/or cost that is not being accounted for. This practice wouldn't exist if the markets were efficient.

It's okay if it seems dumb to you.  That's how it is.

There are frictional costs involved with paying off a loan, and taking out a new one.  But yes, refinancing to lock in a lower rate without prepayment penalty is a great thing for borrowers.

Its not a great thing for borrowers as a whole at all unless you consider events like the GFC a great thing where governments bail out big institutions. Its simply dodgy accounting to hide an obvious risk. Sometimes borrowers will come out ahead and maybe it won't be a problem but the US banking system is simply hiding this risk and the GFC is an example where risks weren't properly accounted for.
« Last Edit: August 27, 2014, 08:44:23 PM by steveo »

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #21 on: August 27, 2014, 09:06:00 PM »
My understanding is most of the rest of the world behaves as you expect. The US is kind of an exception due to heavy(ier) government involvement/backing of housing loans for historical/political/social reasons
http://www.marketplace.org/topics/sustainability/who-thought-30-year-mortgages-were-good-thing
..

Which makes sense. I view the US market as obviously not being efficient. There has to be a cost or risk that is being hidden via following the US approach. To me that is a concern and shows poor banking practices.

Its simply dodgy accounting to hide an obvious risk. Sometimes borrowers will come out ahead and maybe it won't be a problem but the US banking system is simply hiding this risk and the GFC is an example where risks weren't properly accounted for.

I don't think it's hidden at all, the loans are backed by government or government backed agencies, so in a worst case situation the taxpayers are on the hook. It's pretty well understood, it's just not politically desired/feasible to change it.
« Last Edit: August 27, 2014, 09:19:50 PM by CanuckExpat »

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #22 on: August 27, 2014, 09:28:56 PM »
Nope, not tempted. I view fixed rates as a gamble on the future: who's going to pick what happens to interest rates better: me or the bank?

Or think of it as a way to lock in costs.

And then if they drop, lock in again.

When they go up, you're happy you locked in.

Since you can refi when they go down, but the banks can't call it when it goes up, that gives you an advantage. Why would you give that up?

Something to think about.  ;)

in australia, if you want to amend a fixed-interest mortgage, you will need to pay 'Break costs", of 5k, 10k, 20k, some huge amount. 

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #23 on: August 27, 2014, 09:29:29 PM »
I'm curious whether any Australians (like myself) are tempted to fix their mortgage at 5% for 5 years. 

The big banks have just slashed their 5 year rate.....tempting but....


"Happy" has the correct answer:
Quote
Nope, not tempted. I view fixed rates as a gamble on the future: who's going to pick what happens to interest rates better: me or the bank?

steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #24 on: August 27, 2014, 10:40:48 PM »
I don't think it's hidden at all, the loans are backed by government or government backed agencies, so in a worst case situation the taxpayers are on the hook. It's pretty well understood, it's just not politically desired/feasible to change it.

I suppose that is a judgement call but to me its definitely hidden. How many taxpayers do you think recognize that they are on the hook for this ala the GFC ? So I doubt that the average American gets this point at all or would agree to it. Its simply putting the risk onto the American people.


happy

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #25 on: August 28, 2014, 06:41:16 PM »
Oh by the way, banks are not offering fixed rates of 5% because that's where they think interest rates will be for 5 years.

They are doing it because they are able to raise 5 year funding at a rate that allows them to make a 5 year loan that is profitable at 5%.

It's not really a question of betting on rates for the bank, the bank will always win by fixing its NIM (see above). For the ordinary borrower it comes down to personal preference. Certainty of rate vs flexibility of prepaying & variable.

I never realised that Marty998. I always thought  they used some complex actuarial type projections of the likelihood of what the market/interest rates etc would do. Hehehe I think I knew the bank would always win ;)

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #26 on: August 28, 2014, 07:19:14 PM »

Which makes sense. I view the US market as obviously not being efficient. There has to be a cost or risk that is being hidden via following the US approach. To me that is a concern and shows poor banking practices.

Your view is incorrect. There doesn't have to be and there isn't a cost or risk being hidden via following the US approach. Banks tilt their balance sheets to align with movements in interest rates. They don't get screwed over when somebody refinances at a lower rate and the system doesn't asymmetrically favor borrowers as assumed above. Refinancing a mortgage isn't free. Costs are set accordingly. Do people REALLY believe a market that large and liquid would be so obviously inefficient? Seriously?!?! That's just naive to think the big bad borrowers are taking advantage of the poor old banks.

Its not a great thing for borrowers as a whole at all unless you consider events like the GFC a great thing where governments bail out big institutions. Its simply dodgy accounting to hide an obvious risk. Sometimes borrowers will come out ahead and maybe it won't be a problem but the US banking system is simply hiding this risk and the GFC is an example where risks weren't properly accounted for.

You obviously aren't an accountant or financial analyst. Nothing is being hidden. The system works differently perhaps but it IS efficient and it IS in equilibrium. I'm not sure why you keep stating the American system is obviously inefficient and a system like that couldn't work in a capitalist system. It can, does, and has for decades in many different countries, not just the US. The global financial crisis had absolutely nothing whatsoever to do with American refinancing practices.
« Last Edit: August 28, 2014, 07:22:20 PM by kyleaaa »

bigchrisb

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #27 on: August 28, 2014, 09:15:47 PM »
The global financial crisis had absolutely nothing whatsoever to do with American refinancing practices.

Schools of thought differ on this around the world.  Many would contend that the GFC was entirely triggered by US lending structures.  For example, see the wikipeda entry on the GFC.  However, I suspect its such an emotive and potentially patriotic issue that debating it here probably isn't going to benefit anyone.

However, we have probably hijacked this thread on lower fixed interest rates in the Australian market enough.  Perhaps if we want to continue a debate on US lending practices and the GFC, we should start a new thread.

Edited content for contend - I can't spell at the moment!
« Last Edit: August 29, 2014, 05:48:44 AM by bigchrisb »

steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #28 on: August 29, 2014, 01:53:34 AM »
Your view is incorrect. There doesn't have to be and there isn't a cost or risk being hidden via following the US approach.

Can you logically explain how you can fix rates and hedge yourself if the rates go up but if rates go down you simply refinance with no cost. Who is wearing the risk to rates going down ? What happens if banks cannot finance this ? What is the downside not to hedge your loan if this is the way this policy is implemented ?

Banks tilt their balance sheets to align with movements in interest rates. They don't get screwed over when somebody refinances at a lower rate and the system doesn't asymmetrically favor borrowers as assumed above. Refinancing a mortgage isn't free. Costs are set accordingly.

Okay - so there is an interest payment despite what everyone above has said. That makes sense. If there isn't an interest adjustment it doesn't make sense.

Do people REALLY believe a market that large and liquid would be so obviously inefficient? Seriously?!?! That's just naive to think the big bad borrowers are taking advantage of the poor old banks.

Of course this is possible. Have you heard of the GFC ? Have you heard of Long Term Capital Management ? Did companies get bailed out ?

If the interest rules are as you state then that is another example of banks wearing risk (as it should be obvious that they have done multiple times recently) that is not visible anywhere. If the process goes belly up then who pays ? Typically in the American economy your government pays which means the taxpayers pay.

You obviously aren't an accountant or financial analyst. Nothing is being hidden. The system works differently perhaps but it IS efficient and it IS in equilibrium. I'm not sure why you keep stating the American system is obviously inefficient and a system like that couldn't work in a capitalist system. It can, does, and has for decades in many different countries, not just the US. The global financial crisis had absolutely nothing whatsoever to do with American refinancing practices.

Really. Interesting viewpoint. I think if you do some research you might find a lot of holes in your opinion.

Schools of thought differ on this around the world.  Many would content that the GFC was entirely triggered by US lending structures.  For example, see the wikipeda try on the GFC.  However, I suspect its such an emotive and potentially patriotic issue that debating it here probably isn't going to benefit anyone.

Maybe this is a sensitive topic for some. A little bit of logical thinking and research though is probably a good idea.
« Last Edit: August 29, 2014, 05:09:15 AM by steveo »

arebelspy

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #29 on: August 29, 2014, 10:10:06 AM »
Banks tilt their balance sheets to align with movements in interest rates. They don't get screwed over when somebody refinances at a lower rate and the system doesn't asymmetrically favor borrowers as assumed above. Refinancing a mortgage isn't free. Costs are set accordingly.

Okay - so there is an interest payment despite what everyone above has said. That makes sense. If there isn't an interest adjustment it doesn't make sense.

No, there isn't.  There is costs involved in taking out a mortgage (origination cost, for example). The banks get paid to loan the money out.  When you refi, they get paid again.  That's where they're mostly making their money.

Your view is incorrect. There doesn't have to be and there isn't a cost or risk being hidden via following the US approach.

Can you logically explain how you can fix rates and hedge yourself if the rates go up but if rates go down you simply refinance with no cost. Who is wearing the risk to rates going down ? What happens if banks cannot finance this ? What is the downside not to hedge your loan if this is the way this policy is implemented ?

marty998 already explained it:
Quote
They are doing it because they are able to raise 5 year funding at a rate that allows them to make a 5 year loan that is profitable at 5%.

They're already profitable when they make the loan, and when you refi they'll be profitable too.

Allow me to make up some numbers to illustrate a point.

Bank borrows money from the fed at 4%, loans it to you at 5%.  They make money originating it, and make money on the spread.

Rates go up 1%.  You obviously don't refi (unless you're getting cash out), but they don't care, they've already made money.  They borrow new money at 5%, and loan it out at 6% to new borrowers.

Rates go down 1%.  You refi.  They now borrow money from the fed at 3%, and loan it to you at 4%.  They make money originating it, and make money on the spread.

Their profit is not at risk from you refinancing, and requiring a prepayment penalty doesn't suddenly make the system work.  It's fine, or not, but it's not the lynchpin, because you're assuming they hold all the loans to maturity, which isn't even the case.

In any case, all of this is separate from the GFC (and when the GFC occurred, many banks still were doing the prepayment penalty thing - shouldn't that have stopped it, if it was so helpful?).  Subprime borrowing, no doc loans, and especially CDOs caused the issues.  Not having a prepayment penalty or not. 

Trust me, when the GFC happened, and rates dropped, most people couldn't refi to lower rates due to being underwater.  ;)  So a bunch of borrowers suddenly refing to lower their rates was the least of the banks' worries.  Borrowers not paying because they couldn't afford the mortgage they were given was a lot bigger issue.

tl;dr:
1) GFC and prepayment penalties - totally different issues.
2) Prepayment penalties is not how the bank makes money, they make it on origination and the spread they're borrowing at.  If rates drop, and borrowers refi to lower, well, the banks are borrowing it at lower, so it doesn't hurt them.  Prepayment at that point just gives them extra profit.
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deborah

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #30 on: August 29, 2014, 04:41:52 PM »
Another Aussie who never fixed my mortgage.

Interesting conversation about banks and the GFC - US people who have a different story to the rest of the world (or at least all Australians - whose country and banks weathered the GFC better than any? just about all? other country).

steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #31 on: August 29, 2014, 06:23:43 PM »
Another Aussie who never fixed my mortgage.

Interesting conversation about banks and the GFC - US people who have a different story to the rest of the world (or at least all Australians - whose country and banks weathered the GFC better than any? just about all? other country).

Its a funny one isn't it. I don't understand how people can't see the illogical idea of fixing a rate and then getting out of it if it goes against you without there being a cost. I found the comment above hilarious regarding you just keep re-fixing if it goes against you at a better rate.

Futures markets are built on this idea. You hedge your position or speculate. If it goes against you its a loss. If it goes your way its a profit. Interest rates are the same thing.

Its this simple - someone is footing the bill or taking the risk. You can argue to you are black and blue but that is the way markets work. The US isn't special and that has been proven.
« Last Edit: August 29, 2014, 09:47:16 PM by steveo »

Astatine

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #32 on: August 29, 2014, 06:24:11 PM »
Yeah, I'm on my second mortgage (my ex bought me out of the place we bought together) and have always gone variable. I don't think a fixed rate mortgage would have as much flexibility as my current redraw mortgage. Our redraw account has almost instant access to money in the redraw account (just takes the 2 days to transfer electronically to my everyday account with another bank), no restrictions on how little or how much we can put in or take out of the redraw account etc. Our emergency fund is entirely in the redraw account, paying down the mortgage tax free. Makes it easy and painless to pay it down fast.

marty998

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #33 on: August 29, 2014, 07:12:35 PM »
Ahh you're misinterpreting me slightly there arebelspy.

It all depends whether the bank has fixed or floating rate funding.

Say for example a bank has one source of funding - savings accounts from depositors which pay a variable rate (R). The bank lends that money out as variable rate home loans at (R+2%). The bank therefore has a Net Interest Margin (NIM) of 2%.

That 2% then has to pay for bad debts/losses, staff, IT, rent, other exps etc. You end up with a very thin margin for error.

Say a borrower comes along and wants a fixed rate loan. And say the bank lends this out at (R+2%) again.

Fast forward a year and depositor rates have gone up 2%. The bank is now receiving (R+2%) from the fixed loan, and is paying (R+2%) to depositors. the NIM has disappeared, and the bank still has to pay staff, IT, rent, other and cover bad debts. Therefore the bank fails.

To avoid this, the bank will take out an Interest Rate Swap (IRS) with a 3rd party counterparty. In simple terms, the bank will receive fixed interest from the borrower, pay that fixed interest to the counterparty in return for a variable rate from the counterparty which allows it to preserve a desired NIM margin. The IRS goes up and down in value depending on the movements in interest rates.

I digress, but it is likely that the counterparty is also taking out IRS's to hedge its position. You can quickly see how interconnected the world becomes, and when people talk about hundreds of trillions of derivatives (Weapons of mass financial destruction?) this is what they are talking about - just lots of interest rate swaps and foreign currency swaps.

Banks fail, because they do not preserve NIMs that allow it to cover lending losses and costs. The not so technical term in bank treasury speak is ALM - Asset and Liability Management.

If you are looking to invest in a bank, have a look at the track record of the Treasury team executives, and whether there is volatility in the NIM, or non-perfect hedging of the loan book. Will go a long way to preserving whatever investments you have in bank shares.

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #34 on: August 29, 2014, 09:01:55 PM »
Its this simple - someone is footing the bill or taking the risk. You can argue to you are black and blue but that is the way markets work. The US isn't special and that has been proven.

I don't think anyone is arguing with you; there is Prepayment Risk for buyers of US Mortgage Backed Securities. Presumably these are sophisticated investors who understand this (presumably at least), and should be demanding a slightly higher interest rate than they would if there were no prepayment risk.

However, I think it's also well understood that "If the government ever decides to get out of the business of backstopping mortgages, to privatize the mortgage market, economists think the 30-year fixed-rate mortgage -- the mortgage Americans take for granted -- could become a whole lot more expensive, or even disappear. The long-term mortgage is a bet a lot of lenders don't want to take on their own."(http://www.marketplace.org/topics/sustainability/who-thought-30-year-mortgages-were-good-thing).

steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #35 on: August 29, 2014, 09:43:06 PM »
Its this simple - someone is footing the bill or taking the risk. You can argue to you are black and blue but that is the way markets work. The US isn't special and that has been proven.

I don't think anyone is arguing with you; there is Prepayment Risk for buyers of US Mortgage Backed Securities. Presumably these are sophisticated investors who understand this (presumably at least), and should be demanding a slightly higher interest rate than they would if there were no prepayment risk.

However, I think it's also well understood that "If the government ever decides to get out of the business of backstopping mortgages, to privatize the mortgage market, economists think the 30-year fixed-rate mortgage -- the mortgage Americans take for granted -- could become a whole lot more expensive, or even disappear. The long-term mortgage is a bet a lot of lenders don't want to take on their own."(http://www.marketplace.org/topics/sustainability/who-thought-30-year-mortgages-were-good-thing).

Cool. This makes sense.

My impression was that some people don't understand that this is a special situation and is not something that would function if fair pricing (pricing that takes into account risk as well as making a profit) occurs.

If you are looking to invest in a bank, have a look at the track record of the Treasury team executives, and whether there is volatility in the NIM, or non-perfect hedging of the loan book. Will go a long way to preserving whatever investments you have in bank shares.

Correct. In the US market this seems to be provided for via the government.

Its like seeing someone making a massive profit but not accounting for risk. If it works they might look good but when it fails shit hits the fan. In the US if it fails they run to the government.
« Last Edit: August 29, 2014, 09:46:37 PM by steveo »

Primm

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #36 on: August 29, 2014, 10:35:56 PM »
Its like seeing someone making a massive profit but not accounting for risk. If it works they might look good but when it fails shit hits the fan. In the US if it fails they run to the government.

Down here that only works if you're an inefficient car manufacturer, apparently.

steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #37 on: August 30, 2014, 01:22:24 AM »
Its like seeing someone making a massive profit but not accounting for risk. If it works they might look good but when it fails shit hits the fan. In the US if it fails they run to the government.

Down here that only works if you're an inefficient car manufacturer, apparently.

Australia does have its share of stupid shit going on doesn't it. There is a difference though between recognizing stupid shit and trying to argue that stupid shit isn't going on when it is.

I read one of those links and its pretty obvious (of course you have to think logically and use facts) that the US mortgage market is a government backed distortion of free market economics.

Quote
One issue is the 30-year fixed-rate mortgage, a loan U.S. homebuyers take for granted, but is decidedly uncommon in other countries.

And

Quote
That is, great for the borrower. The 30-year fixed-rate mortgage, Bridges says, has all sorts of protections -- for one side.

"One-sidedness comes, No. 1, from locking in that interest rate over an outrageously long period of time," he says.

By locking in the rate, borrowers are protected if interest rates go up -- for 30 years. And, there's no refinance penalty, so they can refinance and lower their costs if interest rates go down.

"It doesn't make it an attractive investment for banks any longer," Bridges says, "and that's why we have the public so heavily involved in underwriting and backstopping domestic mortgagages."

If the government ever decides to get out of the business of backstopping mortgages, to privatize the mortgage market, some economists think the 30-year fixed-rate mortgage -- the mortgage Americans take for granted -- could become a whole lot more expensive, or even disappear. The long-term mortgage is a bet a lot of lenders don't want to take on their own.

To sum it up  - anyone who thinks that the American market is efficient or normal deserves a massive face punch for outright stupidity.
« Last Edit: August 30, 2014, 05:34:51 AM by steveo »

kyleaaa

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #38 on: September 01, 2014, 07:15:18 PM »
To sum it up  - anyone who thinks that the American market is efficient or normal deserves a massive face punch for outright stupidity.

Just because you don't understand something doesn't make it inefficient. You might consider the possibility that others who are a lot more intelligent and knowledgable about the situation than you know what they're talking about.

steveo

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Re: 5 year fixed mortgage interest rate down to 5% in Australia....
« Reply #39 on: September 01, 2014, 08:13:13 PM »
To sum it up  - anyone who thinks that the American market is efficient or normal deserves a massive face punch for outright stupidity.

Just because you don't understand something doesn't make it inefficient. You might consider the possibility that others who are a lot more intelligent and knowledgable about the situation than you know what they're talking about.

Are you serious ???? I think I'm being trolled !!!!

I understand the situation perfectly. Assuming you are serious you need to go and do some research. Try reading through what was posted on here and then go and have a lie down.

You are logically incorrect. You shouldn't be using the word intelligent in anything that you post. You are either ignorant or you have a very low IQ. Its one or the other dude.

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« Last Edit: September 01, 2014, 11:19:58 PM by steveo »