Why fixed rates and floating rates attract you at different points
Australian property tax and expatriate tax expert STEVE DOUGLAS explains why fixed rates and floating rates seem alluring at different points.
Q Why are fixed interest rates in Australia lower than the floating rate on my loan?
A When borrowing to buy an Australian property, lenders in Australia usually offer either a floating (or variable) interest rate, which will change periodically, or fix your interest rate for a set period of up to five years. However, sometimes the fixed rate might be more attractive than the floating – and vice versa. The two factors which influence this are expectation and availability.Expectation is whether the market believes interest rates will rise or fall in the future. Fixed rates are adjusted based on predicted future rates but issues such as the current interest rate policy of the Reserve Bank and the state of the local economy can also influence the outlook of the interest rate. Currently there’s an expectation Australia may experience another rate reduction in the coming year, so we can see this factor being priced in now. There’s no repercussion if the rate reduction doesn’t materialise. The fact that the market believes it may happen is enough to make a difference.
Availability is how much money the banks have in reserve to be readily loaned to prospective borrowers. In 2011 Australia’s lending output was as soft as the property market because many were procrastinating on decisions to buy. So at that point, the Australian banks had too many funds on deposit and not enough lending going out – they had interest cost on the deposit but no revenue coming in. This reduces their profit and costs the bank money. To encourage lending, the bank actually needs to have a “sale” on the interest rate. Once the lending picks up and they start making a profit on the lending margin, the bank will be less generous with the fixed rate offerings.
As a borrower, utopia is when you see a low interest rate policy from the Reserve Bank and a low lending output from the bank. We saw this happen during the Global Financial Crisis in March 2009 when the three year fixed rates in Australia dropped to 5.19 percent per annum. The variable rate was also low but not as low as the special fixed rates on offer. While there was talk rates may have reduced further – it didn’t happen. Within six months the fixed rate had risen to almost seven percent per annum even though the variable was still around six percent per annum. A combination of a higher rate expectation – as the Reserve Bank continued to lift rates – and reducing availability – as more people took advantage of improved conditions and began to borrow again – quickly shifted the fixed rate offering from low end to high end.
I believe a similar situation will occur in Australia this year as activity picks up, even though the RBA is likely to hold rather than lift rates through 2012. This may mean the fixed interest rate is an attractive option for any Australian property investor. To review your loan or check the current interest rates on offer visit www.smats.net.
