Fixed-rate Borrowers Squeezed
Sydney Morning Herald
Tuesday April 12, 1988
IN LAST week's column I warned about the danger of home buyers overextending themselves at a time when mortgage rates have fallen quite steeply.
Certainly, there seems little doubt the fall in rates, by giving people increased borrowing capacity, is prompting many home buyers to take out much larger loans than would have been possible at this time last year.
But a sudden reversal in the rate slide, and so a lift in monthly mortgage repayments, will mean some home buyers will face a severe squeeze.
Given this risk, borrowers may be tempted to try to take out home loans where the interest rate is fixed and so isn't vulnerable to a sudden rate rise.
However, such loans are hard to find. Generally home loan lenders are only prepared to fix rates for a relatively short period, usually no more than three years. As well, at present the rate charged is likely to be slightly above the standard home loan rate.
But whatever the details of fixed rate mortgages, the main drawback is the fact borrowers with this sort of mortgage don't benefit if interest rates fall.
This is well understood by those borrowers who took out the 15.25 per cent fixed rate loans made by St George Building Society during 1986 and 1987. While they initially benefited from a slightly lower rate, they are paying the price now that rates have fallen.
Yet the biggest sufferers are those low-income families who rushed the NSW Government's Premier Low-Start Loans when they were launched in 1986, with the first loans finally being made in early 1987.
While these loans have most of the standard features of low-start loans, in that initially payment of some portion of the interest is deferred until later in the term of the loan, they are unusual in fixing the interest rate for the life the loan, in this case up to 25 years.
When launched, the rate was set at 15 per cent, 0.5 percentage points below the ruling home loan rate. The current rate for new borrowers is 14 per cent, 0.5 percentage points above the ruling mortgage rate.
At the time of the launch the then director of the Department of Housing, Mr Michael Eyers, acknowledged the problems which could arise if interest rates fell, and said attempts were being made to design the loan agreement to ensure there were few, if any, costs if a borrower wanted to refinance at a lower rate with another lender.
It now appears that this attempt yielded few results. A spokesman for the new Minister for Housing, Mr Schipp, confirmed that there are no special arrangements for cutting the cost of refinancing a Premier Low-Start Loan.
In the meantime, low-start borrowers who want to refinance, in most cases, will have to pay normal application, valuation, legal and stamp duty fees. On a $50,000 loan these would cost $600 to $800, depending on the new lender.
The alternative is to keep paying at the old rate of 15 per cent rather than 13.5 per cent and so incur an additional interest cost of just on $700 a year.
Of course, mortgage rates might suddenly rise again. This would be bad news for everyone else except that small minority with fixed rate loans.
© 1988 Sydney Morning Herald