But property investors and homebuyers should be warned. Comparing interest rates can be misleading and focusing purely on the best interest rate can be detrimental to the overall performance of your property portfolio and your buying power going forward.
Interest rates, while important, are not the best indicator of how good a loan is. They may not show you if a loan is the best fit for your situation and they may not help you get the amount you are wanting to borrow. The lowest interest rates advertised are great for advertisers especially those interest rate comparison websites to get commission from lenders by sending traffic or leads to a lender’s website. Most of those “lowest interest rates” or “best interest rates” are likely to be too good to be true.
In this post, I will explain the forces behind mortgage interest rates in Australia, why focusing on the lowest interest rate can be more dangerous than ever and what you should consider when it comes to financing your investment property portfolio.
Why do interest rates increase when the cash rate doesn’t?
The media tend focus a little too much on RBA’s rate decisions. But there are a lot of things that can effect interest rates, below are what I believe the main ones:
1. Government regulators putting pressure on lenders
Government regulators such as the Australian Prudential Regulation Authority (APRA) often place pressure on lenders in order to minimise risk to the lending market and the lenders. It is these pressures that should be monitored in regard to your investment lending.
If the APRA feels there is too much exposure and risk to lenders they will be quick to implement conditions to reduce the risk. The APRA has used their power as regulators to put pressure on lenders in an attempt to curb investment lending in particular.
There are several banks who no longer offer interest only loans to owner occupiers while other lenders have increased their interest rates to interest only loans. Some banks have increased their rates by 0.25% to 0.3% while others have gone up by 0.8%. This equates to around $4,000 per year on a $500,000 loan!
If you have done your loan shopping based only on the best interest rate available and your rate has suddenly increased by 0.8%, it could have serious implications to your property portfolio, your serviceability and your lifestyle.
Ultimately, the lenders are the winners. They can see this as an opportunity to raise their interest rates and blame it on pressure by APRA. It results in hundreds of millions of extra revenue for them.
2. Cost of funding
Approximately a third of all bank funding comes from wholesale funders who are predominantly based overseas. When economies change, for example if the US pushes their interest rates up, this can impact the cost of wholesale funding on our local banks.
When banks and lenders experience increased costs associated with their funding source, these costs are naturally passed on via higher interest rates to the loan holder.
Let’s be honest, banks are there to make money, so they will always pass these costs on to the consumer by way of increased interest rates or lower term deposit rates.
3. Managing lending risk
All banks and lenders independently will try to maintain a balanced portfolio of loans. This means a mix of owner occupier loans, investment loans, commercial loans and so on. APRA has “recommended” that all lenders look at having only 30% of their loan books with interest only and investment lending, where some are sitting at a much higher percentage.The reality is that most banks often go above this limit and will raise the interest rates on these loans thinking it will put pressure on investors and reduce lending in this area.
We don’t think this is the best way to go about it. In my opinion, it should be borrowing capacity that should change and not interest rates on these loans. The banks know this as well… But changing borrowing capacity does not increase revenue.
Some banks have made investment lending harder by not only changing rates but also changing required Loan to Value ratios (LVR) as well. Instead of borrowing up to 95% for interest only loans, with most lenders you can now only borrow 80%. Other banks, however, have increased their charges on investment loans or stopped investment lending altogether.
4. The Reserve Bank of Australia and their projections
Historically speaking, the cash rate set by the Reserve Bank of Australia (RBA) was used as the basis for lenders to increase or decrease their interest rates. However, more recently we have seen banks and lenders increase their rates despite the cash rate remaining the same.
There has been little movement to the cash rate compared to early 90’s, yet in the last 12 months alone, many banks and lenders have increased or decreased their rates numerous times. People often talk about the RBA cash rate and how it will affect their loans, but ultimately the decisions made by the RBA do not influence lenders as much as other factors such as the APRA and the cost of funding has recently.
As a property investor, you may find the reports and projections made by the RBA more beneficial than trying to get the best interest rate based on the RBA cash rate.
Knowing which lenders have what criteria on each loan is far more critical to property investors than focusing solely on the best interest rate. Having a good mortgage broker is more important than ever to make you aware of the current lending criteria for each lender and make sure your loans and financial plan is best for your situation.
Why securing the best mortgage rate isn’t as important as getting the right loan strategies
When buying a property, be it your first home or 5th properties, getting a good interest rate on your loan is important but it should not be a priority over getting the right loan strategies. Sometimes, a loan suited to your situation may have a slightly higher rate than competitors, but with much more favourable conditions.
The difference between a loan with the best interest rate and a loan with better conditions overall may be the difference between being able to afford another property or not.
Interest rates are constantly changing whereas conditions of the loan are usually set when signing for your mortgage. Getting the best interest rate for your loan does not mean you are getting the best loan. Advertising low interest rates is simply the bank’s marketing ploy to get your business. Just because you sign up on a low rate doesn’t mean that rate will stay the same forever, and the rate change might come quicker than you expect.
This was a lesson quickly learnt by a client of mine who came to see me about a bank advert he saw on the television that was offering a loan with a very low interest rate. He was adamant he wanted to apply for lending with this bank because of the low rate they were offering. I laughed when he mentioned the name of the bank and showed him an email I received earlier in the week from the same bank informing me that they intended to increase the interest rate in 21 days.
I also showed this client the numerous conditions that came with this loan, which were conveniently not advertised. It was actually a terrible deal. Taking out a mortgage is not as simply as buying shoes on sale at 50% off. A discount in the interest rate does not equal a good deal overall.
Signing up for an interest only loan for your investment property around mid 4% interest rate may sound like a great deal, but that rate could quickly change and if it’s over 5% and all of a sudden, it’s no longer as appealing as it once was.
What should property buyers do instead of focusing only on the best interest rate?
1. Plan ahead
Regardless if you’re buying your first home if you’re a savvy property investor, you should always be thinking and planning ahead. This will help you work out your financing goals and criteria. A good loan is one that is within your financial means and helps you get to your next investment property so you can build your portfolio. Getting your financial structure in place and your loans set up correctly from the outset is far better than trying to sort it all out when you have a few properties under your belt.
Planning ahead means knowing what you want to achieve with your property portfolio. Do you primarily want capital growth or are you after high rental yields, or maybe both?
Knowing what you want to achieve will be important when it comes time to apply for finance. Lenders have different criteria and it’s important to know what you want to achieve with your property over the next 5 to 10 years in order to structure your loans properly and match the most suitable lender with the property you intend to purchase.
As a property investor, you may want to know if it’s a good idea to cross securitise, I’ve written an article on cross-collateralisation explaining when to cross securitise and when to avoid it. You can read about it here.
It’s also essential that your mortgage broker become very familiar with your situation and your future plans. A good mortgage broker will know the ins and out of each lender and what lenders will be a good fit for your plans. One lender for example, may be more conservative with their lending criteria and may be better to use early on in your investment journey, while another lender may have different criteria all together and may be a good one to save for later when your serviceability becomes tighter.
Focusing on your long-term investment goals rather than worrying about finding the best interest rate will help you get to your goal a lot faster. Everyone’s situation is different and while one particular loan may suit one person, it may not be as effective for another person. So instead of wondering if you should fix your interest rate or take out an interest only loan, you are better off sitting down with your mortgage broker to plan out your finances and lending properly.
2. Focus on the long term
Property investing has always held a certain degree of risk, but a savvy investor will mitigate those risks by investing wisely and investing for the long term. This means understanding the markets where you are investing, diversifying your investments and allowing for fluctuations to lending conditions.
People who have settled a loan less than six months ago and then decide they want to switch loans after seeing an ad for ‘low’ interest rates are not thinking long term. It’s not a good idea to focus on getting the best deal and constantly look at switching banks. Instead you should be focusing on the long-term outcome of your loan. Banks use the low rate offer to lure you in and the conditions on these loans can often leave you worse off. Interest rates can change at any time. For example, one bank raised their interest rates by nearly 1% overnight, and incidences of this is becoming more and more common.
Online comparison websites can also be particularly bad for making consumers think of short term gains rather than long term goals. I’m sure you know as much as I do that they do not have your best interests at heart. They are simply marketing tools driven by big media organisations. They will not always explain the complicated terms and conditions and will often overwhelm you with paperwork and confusing jargon. It’s highly unlikely they’ll talk you through a loan and the overall long-term results like a dedicated mortgage broker can.
3. Borrow within your means
Rather than focusing solely on finding the lowest interest rate, you are better off buying within your means and getting the best loan structure set up for you.
Instead of spending $800,000 on a property that will stretch you beyond your financial capabilities, re-adjust your focus, lower your budget and look for a property more within your means. This will lower your risk and reduce the chances of any rate increases significantly affecting your lifestyle. It may even increase your chances of buying again in a shorter amount of time.
Stress levels can quickly rise if you find that increased interest rates or a drop in house prices has had a serious impact on your finances. You should always have a financial buffer in place and speak to your mortgage broker about how comfortable you are with risk. If you know that you are more conservative when it comes to risk, your broker can talk you through your options to ensure you are heading towards your goals while still keeping your borrowing well within your means.
4. Review your borrowing portfolio regularly
Just like interest rates, the property market is constantly changing. This means the performance of your property and borrowing portfolio will likely change over time. Some properties may decrease in performance while others perform better than expected. Or the interest rates on your loans may have changed so much over time the loan is no longer the best option for you. It’s always advisable to review your portfolio on a regular basis…At Mortgage Corp, we normally review our client’s loan at least once a year.
Reviewing your portfolio means taking a good look at how each of your properties are performing and whether the loans on these properties are still working effectively for you. Are your properties still working to get you closer to your long term financial goals?
Has one of your properties experienced early capital growth but that has slowed over recent years. Should you consider selling and investing elsewhere?
Is another property performing far better than expected and you’ve managed to raise the rent a few times making the property positively geared? Should you consider switching from an interest only loan to a principal and interest loan early to pay down the property faster?
Regular reviews of your portfolio will allow you to monitor your properties and adjust so you stay on track to reach your ultimate goal. Regular reviews also allow you to look at your loans and current lending conditions to see what has changed and if you are in a position to refinance and draw out equity.
5. Get the right advice
An experienced mortgage broker should always be included in your property expert team of advisers, and you should be in touch with your broker on a regular basis. Talking to an experience and highly skilled mortgage broker can make the world of difference to your property portfolio and your long-term goals. The service is free anyway, so why not take advantage of the knowledge a good broker gathered during their many years of experience with property lending.
Instead of trying to work out whether you should fix your interest rate or pay interest only, sit down with your mortgage broker and make a proper plan tailored to you and your personal circumstances. Everyone’s situation will be different and everyone will have different requirements. Fixing interest rates might work well for one person but be a big mistake for another.
A good mortgage broker will work out your serviceability based on principal and interest repayments, even if you are taking out an interest only loan. So even when your interest only period ends, you can still afford the repayments.
Mortgage brokers deal with lending bodies every day, we know that there is more to be factored into mortgages than just the interest rate. Rather than going with a comparison website, which only offers loans from lenders who have signed up to advertise on that website, a mortgage broker can sit with you and answer all your questions and work through different scenarios based on your situation.
To invest in property wisely, it’s imperative to cover your bases in relation to the points outlined in this article. Rather than trying to find the best interest rates, invest smart, buy within your means, focus on your goals and work closely with your mortgage broker to ensure you getting the best loans to suit your needs.
As a property investor, trying to find the best interest rate for your loans instead of looking at the overall loan conditions will do you more harm than good.
Take advantage of our Free Loan Structuring Strategy Session today and let the experts guide you to not only getting a loan but building a solid property portfolio.