Rates are going down one way or the other, regardless of what the RBA does. In this fortnights update we talk about the competition driving rates down, your borrowing power going up and why that will increase prices.
Borrowing capacity
Rates are going down whether the RBA drops the cash rate again or not.
There is intense competition for home loan borrowers right now and this is not going to abate. The big banks still have around eighty percent of the market between them, but the competition is knocking on their customers doors.
Besides the clear benefit to people with lower rates meaning lower repayments and costs on home loans and business loans, the other major benefit is that your borrowing power will increase.
The increase in borrowing capacity is more subtle than seeing a lower dollar figure in repayments but it is a critical benefit for many people and businesses.
The reason lower rates influence borrowing capacity is that it lowers the serviceability of the loan. As in, how you can service / pay back the loan based on the lower rate.
For home loans even though your rate might be three percent they will assess your ability to repay the loan at five plus percent. This is mostly a risk mitigation factor to give the bank a buffer if something happens to your income or rates go up.
But rates are not going up.
They are going down. There is a lot of speculation that the RBA will drop the cash rate from 0.25% to 0.10% at their November meeting on Melbourne Cup day and it honestly seems like it will happen.
Right now, the lowest home loan rates are between 2% and 2.19%. These are fixed rates not variable and it is highly likely we will see big banks getting to a common 2% home loan rate across the board, just as I predicted in an update back in July.
That might sound crazy because it is and especially because it means we are moving from historical low rates to even lower low historical rates.
But the truth is it is not that crazy at all.
With the central bank offering banks low cost funding and plenty of capital floating around global capital markets money has never been cheaper.
That means you can borrow more, for less, which will influence prices higher.
Bidding upwards
The more one can borrow the more one usually spends.
(See servicing above).
This is as true for property as it is with almost anything else, but it makes a really big difference in the property market.
For example, if you can borrow a million dollars you will probably buy a property using all of that amount. If you could borrow only eight hundred thousand you would probably spend all of that as well.
The difference is what can see property prices get pushed up, particularly at an auction.
When multiple bidders are vying for a property their borrowing power basically determines when they can wave the paddle to bid.
If the price of the property reaches a nine hundred thousand and you can only borrow eight hundred thousand you are out of the contest.
If you can borrow a million you can keep bidding up the price.
The price will go up as high as someone is willing and able to borrow and pay for it.
This will continue to push prices up.
This is an over simplified example, but it illustrates a very real and common scenario that happens at many auctions. It is in fact exactly the scenario the auctioneer and vendor sales agent want to see and try to create to maximise the price, that is the job, to get the highest price for the seller.
Compounding this is ‘FOMO’.
The ‘Fear of Missing Out’ is a very real mental phenomenon, and as we have talked about in earlier updates, stems from a psychological theory around loss aversion, basically saying that people will make decisions to avoid losing to more of an extent than they would of winning.
People do not want to lose, so they will bid, and they will bid to as much as they can borrow.
Banking-as-a-failure
This is off topic, but I want to speculate on a major bank’s future.
Westpac has just announced they are going to rent their banking license to Afterpay moving to a banking-as-a-service model which will see Afterpay offer their customers savings accounts that are operated by Westpac.
This is exactly what I was talking about a few updates ago about fintechs moving to own the customer experience and banks becoming a basic utility provider.
This is as well as Westpac being hit with a $1.3 billion dollar fine for the anti-money laundering issues that saw the previous CEO lose his job, continuously being plagued by technology issues and selling out of Zip Co.
All of this screams like a business trying to survive, not thrive.
They also have huge amounts of risky exposure in property residential and commercial lending from buying market share which could ultimately be their failing.
So, my speculation is that perhaps the bank we know as Westpac today will not survive the next decade or even few years. Who knows, maybe Afterpay or another fintech will end up having a larger market share and buying parts of or all of the bank.