Not so fast: Why the RBA may not cut rates

Not so fast: Why the RBA may not cut rates

With paying only $1.45 for a cut, and $2.60 for no change, you may say the smart money is on an RBA cut for tomorrow.

But with the market only pricing in a 64 per cent chance of a rate change, it’s far from a sure thing. There are likely a few questions in Glenn Steven’s mind ahead of one of his last meetings as RBA chief. 

  1.  Fear of spurring on house prices further

Australia’s two biggest cities have very high house prices. Exorbitantly high in some areas of Sydney, with prices up another 9 per cent in the year to July 31. That’s around 80 per cent growth since the slight breather they took during the GFC. Most of the growth was in the last few years. 

On the other hand, there’s Perth down 5.61 per cent and Darwin down nearly 8 per cent. Hobart is only up 2.3 per cent in the seven and a half years since the GFC. Even with today’s abysmally low term deposit rates, you’re still able to get that return in a year, government guaranteed. Australia’s housing market is a mixed bag, but one thing is for sure – in the absence of other factors, RBA cuts encourage people to borrow more, and this drives up prices.

The saving grace here is thanks to the RBA’s mates over at APRA, the banks are already reining in investor and low deposit lending, which are the two hot topics as far as house prices go. If you live in your property and have more than 20% equity, based on current deals in market 98.67% of the last 3 RBA cuts have been passed on to you (if your lender didn’t – time to look elsewhere!).

In contrast, if you’re an investor with only 5 per cent equity, you will have missed out on 44 per cent of those cuts, by way of lenders starting to charge more for investors and people with low deposits. We’ve seen the emergence of the ‘Ideal Borrower’, and they’re getting rates 0.33 per cent lower on average than less than ideal borrowers. The banks have been doing this over the past year as a result of stern warnings from APRA about shoring up their balance sheets and limiting their growth in investor lending to 10 per cent at most. They do this by charging more for the less than ideal borrowers, and offering extra hot rates to their ideal borrower. 

2. Knowledge the cuts are losing their punch

We’re at historic low rates already… for Australia. Many similar countries (think Europe and Japan), are at zero or negative official interest rates.

The RBA is lucky enough to have witnessed countless other economies on their journey to zero. They’ve got there for a reason – low rates are one of the main tools available to central banks when they are looking to grow their economies.

The idea is that with lower rates, two main things happen for consumers. Firstly, you’re getting less in return for keeping your money in the bank, so you have an incentive to spend it or invest it elsewhere in the economy.

Secondly, and this is a big factor for our property-obsessed economy and variable rate normal home loans, with lower rates, people pay less on their mortgage and have more money to spend elsewhere. Or you can put in back into your home loan to pay it down much quicker. Either way, the more spare cash / less debt situation is aimed to get you spending more, sooner. 

The problem for the RBA here is that each extra cut has a little less impact on the economy, and as they approach zero, there’s less of them in the tank for future use.

The RBA has been slowly trimming rates for a long time now, and consumers have learned that this is generally the sign of a weak economy, be it local or global. We saw a double cut of -0.50 per cent in May 2012 and multiple full 1.00 per cent cuts when the GFC was peaking back in late 2008 / early 2009.

With a current RBA rate of 1.75 per cent, they know they have to use each cut increasingly wisely. This adds up to a growing hesitation to cut in any given month, and this applies to the August meeting as much as any.

What does this mean for borrowers?

 Regardless of what the RBA decides to do, there’s some lessons in there for borrowers, and potential borrowers.

Firstly, when searching for property and weighing up whether to take on a new home loan, make sure you have a close look at what the market you’re buying into has been doing, to help work out what it’s going to do in your first few critical years of a home loan – where debt is high and only a small portion of your repayments go towards paying down that debt (most will go towards covering the interest).

Secondly, if you’re an ‘ideal borrower’ (remember: living in the property, with 20% or more equity), you’re hot property for lenders so make sure you’re getting a good deal – look for under 4 per cent even before any more RBA cut.

Finally, gone are the days you need to wait for the RBA to give yourself a rate cut. There’s over 100 lenders out there and they set rates based on a range of factors, the RBA is only one of these. Lenders are actively on the hunt for new customers, offering extra low rates to get you in the door.

At very least, compare what rates are available, arm yourself with the right info and get on the phone to your lender. It could be a very valuable phone call, and be ready to switch if you don’t think you’re being looked after.

If you’re on an average rate, switching to one of the lowest rates on the market will give you 3 RBA cuts or more all in one go, and that’s before Tuesday’s meeting even starts.

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Learn more about home loans

How much of the RBA rate cut do lenders pass on to borrowers?

When the Reserve Bank of Australia cuts its official cash rate, there is no guarantee lenders will then pass that cut on to lenders by way of lower interest rates. 

Sometimes lenders pass on the cut in full, sometimes they partially pass on the cut, sometimes they don’t at all. When they don’t, they often defend the decision by saying they need to balance the needs of their shareholders with the needs of their borrowers. 

As the attached graph shows, more recent cuts have seen less lenders passing on the full RBA interest rate cut; the average lender was more likely to pass on about two-thirds of the 25 basis points cut to its borrowers.  image002

How much deposit will I need to buy a house?

A deposit of 20 per cent or more is ideal as it’s typically the amount a lender sees as ‘safe’. Being a safe borrower is a good position to be in as you’ll have a range of lenders to pick from, with some likely to offer up a lower interest rate as a reward. Additionally, a deposit of over 20 per cent usually eliminates the need for lender’s mortgage insurance (LMI) which can add thousands to the cost of buying your home.

While you can get a loan with as little as 5 per cent deposit, it’s definitely not the most advisable way to enter the home loan market. Banks view people with low deposits as ‘high risk’ and often charge higher interest rates as a precaution. The smaller your deposit, the more you’ll also have to pay in LMI as it works on a sliding scale dependent on your deposit size.

What are the pros and cons of no-deposit home loans?

It’s no longer possible to get a no-deposit home loan in Australia. In some circumstances, you might be able to take out a mortgage with a 5 per cent deposit – but before you do so, it’s important to weigh up the pros and cons.

The big advantage of borrowing 95 per cent (also known as a 95 per cent home loan) is that you get to buy your property sooner. That may be particularly important if you plan to purchase in a rising market, where prices are increasing faster than you can accumulate savings.

But 95 per cent home loans also have disadvantages. First, the 95 per cent home loan market is relatively small, so you’ll have fewer options to choose from. Second, you’ll probably have to pay LMI (lender’s mortgage insurance). Third, you’ll probably be charged a higher interest rate. Fourth, the more you borrow, the more you’ll ultimately have to pay in interest. Fifth, if your property declines in value, your mortgage might end up being worth more than your home.

Does Australia have no-deposit home loans?

Australia no longer has no-deposit home loans – or 100 per cent home loans as they’re also known – because they’re regarded as too risky.

However, some lenders allow some borrowers to take out mortgages with a 5 per cent deposit.

Another option is to source a deposit from elsewhere – either by using a parental guarantee or by drawing out equity from another property.

What is a low-deposit home loan?

A low-deposit home loan is a mortgage where you need to borrow more than 80 per cent of the purchase price – in other words, your deposit is less than 20 per cent of the purchase price.

For example, if you want to buy a $500,000 property, you’ll need a low-deposit home loan if your deposit is less than $100,000 and therefore you need to borrow more than $400,000.

As a general rule, you’ll need to pay LMI (lender’s mortgage insurance) if you take out a low-deposit home loan. You can use this LMI calculator to estimate your LMI payment.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

Will I be paying two mortgages at once when I refinance?

No, given the way the loan and title transfer works, you will not have to pay two mortgages at the one time. You will make your last monthly repayment on loan number one and then the following month you will start paying off loan number two.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out. 

Can I get a home loan if I am on an employment contract?

Some lenders will allow you to apply for a mortgage if you are a contractor or freelancer. However, many lenders prefer you to be in a permanent, ongoing role, because a more stable income means you’re more likely to keep up with your repayments.

If you’re a contractor, freelancer, or are otherwise self-employed, it may still be possible to apply for a low-doc home loan, as these mortgages require less specific proof of income.

Is there a limit to how many times I can refinance?

There is no set limit to how many times you are allowed to refinance. Some surveyed RateCity users have refinanced up to three times.

However, if you refinance several times in short succession, it could affect your credit score. Lenders assess your credit score when you apply for new loans, so if you end up with bad credit, you may not be able to refinance if and when you really need to.

Before refinancing multiple times, consider getting a copy of your credit report and ensure your credit history is in good shape for future refinances.

I have a poor credit rating. Am I still able to get a mortgage?

Some lenders still allow you to apply for a home loan if you have impaired credit. However, you may pay a slightly higher interest rate and/or higher fees. This is to help offset the higher risk that you may default on your repayments.

I can't pick a loan. Should I apply to multiple lenders?

Applying for home loans with multiple lenders at once can affect your credit history, as multiple loan applications in short succession can make you look like a risky borrower. Comparing home loans from different lenders, assessing their features and benefits, and making one application to a preferred lender may help to improve your chances of success

If I don't like my new lender after I refinance, can I go back to my previous lender?

If you wish to return to your previous lender after refinancing, you will have to go through the refinancing process again and pay a second set of discharge and upfront fees. 

Therefore, before you refinance, it’s important to weigh up the new prospective lender against your current lender in a number of areas, including fees, flexibility, customer service and interest rate.