I mentioned in a recent article that when it comes to interest rates I am not a clairvoyant and so it has proved to be. The reasons why will be revealed soon enough but rst a bit of recent history. Until relatively recently banks set their home loan and residential property investment rates in accordance with the Reserve Bank cash rate. That is, if the Reserve Bank dropped the cash rate then residential property rates followed and vice versa. A little while back one of the major banks announced that it would no longer blindly follow the cash rate benchmark and instead make rate decisions that it considered appropriate to an assessment of its total cost of funds. To no great surprise given the almost monopoly competition conditions in the Australian banking sector the other major banks quickly followed. What we have seen as a result is banks setting rates on the basis of cost of funds and some moderate competitive forces. Obviously there has also been considerable public and political pressure to keep residential property nance rates low. After all, is it not a god given right for every Aussie to own their own home? The net result of recent events has been historically low interest rates and ready access to cheap money. No doubt the banks would have loved to lift their prot margins on these loans but have been concerned about political and public backlash. Well, things are shifting and fast. After much talk about an overheated residential property investment market in Sydney and Melbourne combined with changing capital adequacy benchmarks the banks have now got a politically and perhaps economically palatable reason to move credit policy and rates and they have, almost unilaterally, done so. The result is higher rates for existing and new residential property investors and a tightening of credit standards. In some cases banks have simply stopped doing interest only residential property investment nance and in others they are charging higher rates for interest only and for higher gearing. Here’s the thing. If you are trying to slow investment property credit growth in Sydney and Melbourne why raise the rate for an existing sub 80% geared borrower with property investments in regional Queensland. The answer is pretty simple. The banks feel that the political climate is such that they can get away with it and sadly they are probably right. Frankly, as a regional Queensland property investor I really wish that market was overheated but the truth is that it’s gone nowhere for years. Upping borrower rates on existing low geared debt to quell a new borrower market dynamic that does not exist is a simple margin grab and frankly looks like a cynical and expedient way for the banks to extract more revenue from existing borrowers. So, is there any merit in these recent developments? I think there is. If interest rates are supposed to reect lender risk then I think higher rates for interest only loans and for higher gearing makes some sense. If I lend you $500,000 at 90% gearing on interest only terms there seems little doubt that you are a higher credit risk than an 80% geared borrower who is paying o the loan. Risk is all about borrower repayment capacity and gearing. The higher the gearing and the less paid o the debt over time then the higher the medium term risk of the asset value falling (and gearing rising as a result) or the borrower being unable to meet future P and I repayments. I have no fundamental problem with rates reecting this risk. The question for business and commercial property borrowers is whether this trend will trickle down to these type of loans. Stop worrying, it already has. Business and commercial debt is priced dierently and credit risk has been built into these rates for years. It’s called the client margin and essentially reects the earn the bank wants commensurate with the risk grading of the transaction. In the past few years I have seen very little dierentiation in business rates on gearing or interest only versus P and I. Given recent events in property investment nance I expect this to change sooner rather than later. The bottom line is that out of left eld there may now be a very good reason to look at xed interest rates. It’s got little to do with the economy or the cash rate and everything to do with the political environment and the manner in which our banks operate. To many I suspect that the fact that the four major banks move in almost complete unison suggests to some commentators a lack of competitive vigour at best and something approaching collusion at worst. I think the truth is more to do with four very large institutions operating in a relatively small economy in which strategic options to dierentiate on price are limited. Having said that the recent decision by some banks to lift existing property investor borrower rates across the board appears to be unsophisticated margin gouging to say the least. There now seems little doubt that we are entering a period of higher interest rates for interest only nance, interest rates matched to gearing percentages and lower gearing tolerances across a range of assets plus more onerous debt servicing guidelines. In short, I think both personal, investment and business debt is about to get a bit more expensive and bit harder to get. Even so, money will still be comparably cheap and readily available for the right applicants. How a deal is presented to your bank remains very important and as my mum always says, only one chance to make a rst impression. Lastly, if you are intending to acquire an asset in your SMSF and use debt to do so best move now. In my humble opinion the days of SMSFs borrowing to acquire property investment assets are coming to an end and fast.
Mike Phipps Director | Mike Phipps Finance