Pressure is building inside the big banks to raise rates as funding costs rise, but what does that mean for borrowers and what can they do about it?
In this update we talk about funding costs, second tier lenders, refinancing and why they matter to you and your clients.
To start with, a few ‘second tier’ lenders such as Macquarie, ING, AMP, Pepper and BOQ have all announced interest rate increases citing funding costs as the reason. As at time of writing, none of the big 4 have raised rates, but we expect after one does the others will follow, as always. However, the big banks also have their balance sheet muscle to flex, so we have seen them also go the other way with ‘holiday’ rates to entice borrowers and buy market share, but these offers are temporary.
The reason funding costs are so important to banks and lenders is “NIM” or Net Interest Margin, which significantly impacts their profitability. Effectively, lenders need to balance the cost of borrowing money against lending the money to other borrowers.
When a bank claims they “must” raise rates due to higher funding costs they are effectively saying that they need to maintain their profit margins (‘NIM’). This is an opportune time for savvy borrowers to be comparing their options and saving themselves money by getting a better deal, especially by refinancing with a more competitive lender.
There are challenges for refinancing ‘IO’ (Interest Only) loans but borrowers need to be aware that even a 6 “bips” or 0.06% increase on a $750k mortgage is ~$60 per month or $720 a year extra that they will need to pay. While refinancing is sometimes challenging it is worth it.
We predict more lenders will raise their rates, also citing funding costs. The big 4 are yet to raise, but they will likely increase rates by September or October which is their end of financial year.
If your clients are asking about why their rates are going up, Skyward Financial is able to explain the situation and evaluate their current mortgage and see if a better deal through refinance is available.
The Key Takeaways
1. Funding Costs
We have discussed how banks rely on ‘NIM’ so when lenders cite funding costs as the reason for increasing rates, they are protecting their profit margin. Borrowers should be open and active in using a broker or comparing their options. Don’t protect the banks’ profit margins by being inactive.
2. Second tier lenders
The big banks often have stringent criteria and conditions for loans and if they do not meet a certain standard or level then they will not do the loan.
Borrowers should be exploring options with lenders that are not a big bank. We cover more on these types of lenders later in this report.
3. Refinancing
Over a 30-year term your mortgage rate will change (economic cycles, monetary policy, funding costs) so it pays to consider a ‘mortgage strategy’.
This includes looking past the headline rate and considering the features and benefits most suitable to your objectives, such as having an offset account or redraw facility and the structure (IO vs P&I).
Refinancing is the best way to get the sharpest rate and the optimal structure for a home loan.
If you or your clients have had a mortgage for a few years it might be worthwhile to let Skyward Financial evaluate your loan, which is a free service.
What are “second-tier” lenders and are they second rate?
Don’t mistake the term “second” as inferior, it is simply a hierarchical label between the ‘big 4’ (CBA, NAB, Westpac, ANZ) and smaller banks and non-bank lenders. The kind of lenders in this “second tier” include: Macquarie Bank, Suncorp, Beyond Bank, BOQ, Citi, ING, Bankwest, Bank of Melbourne, St George and Adelaide Bank.
It is worth pointing out that second tier lenders are not always banks, and that technically to be a “bank” in Australia the institution needs to hold a banking license from the government. Many of these second tier, specialist or alternative lenders are classified as ‘non-bank’ lenders. This means they might not have banking operations such as ATMs, credit cards or transaction accounts, but they have mortgage facilities.
Often when a non-bank lender specialises in a certain type of loan they can do it better than banks. This includes, for example, commercial property, an area which Skyward Financial also specialises in.
The Australian Bureau of Statistics states in their latest housing data that ‘non-bank’ lenders’ market share recently rose by 83 points to 7.85%. This is quite a significant increase given Australian mortgage debt is sitting at around ~$1.7 trillion. We see a continued trend in borrowers moving away from the big banks to non-bank lenders and expect this to continue.
A few of these non-bank lenders have recently raised rates, but they still have a niche and are very competitive on rate, product and service, and are more open to lending when big banks won’t.
For example, for “non-conforming” loans i.e. loans that do not tick the right boxes at banks, can be placed with a specialist or alternative lender. Specialist lenders are very strong contenders for the self-employed, borrowers with credit defaults or low doc options. But they are also good options for investors and general borrowers looking to borrow a higher LVR or a situation that isn’t ‘standard’.
The point here is that there are always options, either at banks or at non-bank lenders.
Skyward Financial works with the big banks and second tier lenders and can help find the right lender for simple or complex loans.
Refinancing
It pays to refinance and look for a better deal. The average mortgage term for a residential property is 30 years so it is important to have the long term in mind and how to manage the loan, which includes monitoring refinance options.
This is why we talk to clients about having a ‘mortgage strategy’. This means not just being focused on the rate and considering features and tactics to manage the mortgage and includes having an offset account, redraw facility and the optimal structure (fixed/variable, IO or P&I).
Skyward Financial aims to be a trusted finance partner for the long term to help clients manage what are usually their biggest financial commitments.
There are myriad reasons when refinancing is the optimal choice for borrowers, which include:
- Switch rate types
Between variable and fixed there are pros and cons, read more on our blog https://www.skywardfinancial.com/blog/should-you-get-a-fixed-or-variable-interest-rate-with-a-mortgage
- Restructuring to suit changing needs
Perhaps a lower repayment over the short term is desirable, or cashing out equity for renovations or when unexpected costs arise
- Lowering the repayment
If equity has been built, then refinancing a reduced principal loan amount could mean lower repayments, saving borrowers money
- Structuring P&I or IO repayments
Many borrowers currently with IO loans are looking at increases when the loan automatically switches to P&I. Refinancing ahead of time can prevent this
Speak to Skyward Financial today to refinance or about anything contained within this update.
Note all information in this update is general in nature and does not take into account specific situations.
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