Banks Retake The Lending Strip
The Age
Monday December 18, 1995
Home buyers should be warned that a change in market conditions can turn the tables on `fringe' mortgage lenders, writes Daryl Dixon.
THE financial collapse over the past year of three firms that were involved in arranging first-home mortgages highlights the need for all borrowers to scrutinise their mortgage contracts closely. The last thing that any borrower wants is having to refinance their home mortgage at a time not of their choosing.
So far, the collapse of some fringe mortgage originators has been confined to small firms charging commissions or taking a small percentage margin for arranging mortgages for home buyers. These firms have been acting as intermediaries between the borrowers and lenders, such as, superannuation funds, life insurance and trustee companies, mortgage funds and other similar organisations with money to invest.
The growth of the fringe mortgage-originator business has been driven by the reluctance of the traditional mortgage lenders, the large banks, to reduce their profit margins. By offering variable interest rate loans at less than the standard bank variable mortgage rate loan, the fringe lenders have been having a field day at the banks' expense.
This burgeoning business does not, however, mean that the firms involved in arranging the fringe mortgages will continue to make substantial profits from their new line of activity.
The banks recognise that a most significant part of their very profitable business is under threat and, even if belatedly, are developing strategies to fight back.
The banks' strategy has three elements. The first is a heavily discounted mortgage rate for the first six or 12 months of the mortgage . The fringe mortgage originators do not have the deep pockets required to compete with the banks' special offerings.
Second, the banks are undercutting their traditional variable home mortgage interest rate by offering attractive fixed-interest rates for specific periods.
Third, a more recent development is the action by St George Bank to offer a special discount on the variable interest rate charged to long-standing customers.
In the home-mortgage business now, the banks are also prepared to negotiate with their best customers in order to retain their business. This is almost certain to be the area in which the banks concentrate their efforts. For one thing, it is a less costly strategy than offering deep discounts to attract new clients.
Home buyers contemplating deserting their bank to do business with a fringe mortgage originator should understand that the financial markets over the past year have been as favorable for the new mortgage lenders as they are likely to be for some time. The key feature of financial markets has been the relative stability of short-term interest rates and a fluctuating though declining trend in medium-term rates.
In order to increase their fixed-interest investment yields, the superannuation funds and life insurance companies have been keen to finance the mortgages arranged by the fringe originators.
So far, the collapse of several mortgage originators has been dealt with easily, with the mortgages remaining in force and administration taken over by other groups. The lenders concerned have been only too happy to keep their mortgages going.
This does not mean, however, that this will always continue to be the case if financial markets change and short-term interest rates start to rise again. With inflation and wage increases on the rise, increases in short-term interest rates could occur quite quickly. In this situation, the variable interest rates charged on the fringe mortgages will start rising with short-term rates. The typical fringe mortgage loan charges an interest rate linked to the 90-day bank bill.
The problems in real estate markets in many parts of Australia, and the emergence of increasing numbers of loans where the owners have a negative equity in their property, could dampen the enthusiasm of investors for mortgage loans. This has been the experience in parts of the United States and in Britain, where fringe-mortgage lenders are insisting on mortgage insurance coverage on many of the mortgages they finance.
Understanding the basic facts will help home buyers who are shopping around for the best mortgage rates. Borrowers should remember that what seems a good deal today could prove to be a lemon in the future.
To avoid this risk, one strategy is to deal only with lenders with close ties to organisations (including the superannuation funds and life insurance companies) that are funding the mortgage.
There are more risks with fringe players.
Borrowers in the fringe market need also to receive professional advice on the precise details and hidden catches, if any, with the mortgage document they are signing. In addition to full information about how the interest rate is determined, investors should be informed precisely about the terms under which the mortgage can be terminated.
Fringe lenders are unlikely to be as tolerant as the banking system can be of temporary or permanent lapses in the regular servicing of mortgage interest payments.
Daryl Dixon is the author of `Daryl Dixon's New Super Strategies' ($19.95) and `Daryl Dixon's Do It Yourself Tax and Investment Strategies' ($24.95), from Information Australia.
© 1995 The Age