The big banks could cut their variable rates much lower, but by how much?
Many Australians, towards the end of each month, are faced with the sometimes daunting task of paying off their variable rate home loan in principal and interest.
Have you ever wondered how a bank calculates what this variable rate should be?
And once you figure that out, can you determine if the owners are actually getting a fair deal?
Let’s explore this.
How are variable rates determined?
At a very basic level, a bank will choose an interest rate that is higher than the interest rate it pays on the funds it borrows to lend you.
The bank makes money by borrowing at a lower rate and lending you money at a higher rate.
To finance variable rate loan products, commercial banks use short-term money markets, as opposed to longer-term markets that finance fixed rate loans.
Banks have many sources of funding covering various markets, products and maturities.
The most important rate, however, in terms of bank financing costs, according to the Reserve Bank, is what is known as the 3-month banknote exchange rate (BBSW) – this is the rate at which they can issue “banknotes” to wholesale investors.
This is the rate at which banks lend each other.
Quite simply, it is the cost for the banks to issue IOUs to get their variable loans.
The cost of this IOU is currently around 2-3 basis points, or 0.02 to 0.03 percent.
So the BBSW determines the cost of your variable rate mortgage?
But that’s not what commercial banks would have you believe.
The Australian Banking Association (ABA), which represents the major banks, told the ABC that the Reserve Bank’s cash rate target, or “cash rate” for short, is the primary benchmark used. by banks to calculate their variable interest rates.
“The RBA cash rate is not the only data a lender should use to determine their standard variable rates, but it is an important data in the cost of the loan,” noted a spokesperson for the loan. ‘ABA.
“Other costs and inputs that determine the extent to which a change in the RBA’s cash rate affects banks’ lending rates include the cost of funds provided by banks, the structure of their deposits, and interest rates. , and the risk profile of the loan. “
The Commonwealth Bank, the largest provider of variable rate loans to mortgages, declined to comment on how it determines the cost of its variable rate loans.
Cost confusion rate
Do you see where this is going?
The Reserve Bank says banks pass on the cost of borrowing money in short-term money markets to borrowers (home loan customers).
The cost of this is around 0.03 percent for banks – an all-time low.
The Australian Banking Association, on the other hand, claims that banks use the Reserve Bank’s cash rate target.
So what is the RBA’s cash rate target?
Well, it’s really nothing more than a price signal that the RBA uses to move the BBSW higher or lower.
It’s 0.1%. 100 currently.
But it is 0.07 percentage point above the BBSW.
To be fair, the BBSW is recognized as a factor in the total cost of an adjustable rate loan to a bank.
The embarrassing truth is that this is the most important factor.
So the banks claim that one of the costs of finding funds for your variable rate home loan is higher than it actually is.
The pandemic is behind the confusion
Velocity Trade banking analyst Brett Le Mesurier points out that, before the pandemic, the BBSW largely aligned with the Reserve Bank’s cash rate target (the two were highly correlated).
Printing large amounts of money reduced the value of money to next to nothing.
Thus, while the Reserve Bank’s cash rate target is 0.1%, the market values “cash” (BBSW) at only 0.03%.
“So it was easier for [the banks] to explain to their retail customers that the standard variable rate was changing because the spot rate was changing, but the greater truth was that it was because the BBSW was changing, ”he said.
He said “of course” that banks could lower the cost of their variable rate mortgage products, but logistically they just couldn’t handle the resulting increase in demand.
“They don’t have a whole bunch of people twiddling their thumbs,” said Le Mesurier.
In addition, investors would bear the cost with lower returns on investment, as the bank would make less money overall.
Are you paying too much?
But there is still an inconsistency.
There is a pretty big difference between what the average customer at a large bank pays for an existing variable rate loan and what is offered to a new home loan customer.
The latest data from the Reserve Bank shows that the average homeowner mortgage rate for existing customers is 2.92%, while the average rate for new customers is 2.42%, a difference of one-half. – percentage point or 0.5%.
Existing Homeowner Mortgages
New Homeowner Mortgages
It makes a huge difference in your monthly mortgage payments, ”said Sally Tindall, Research Director of RateCity.
“For example, on a 30-year, $ 500,000 home loan at 2.92%, you would pay just over $ 2,000 per month.”
“A new customer, on the other hand, would pay $ 132 less per month.”
Up to the customer
Commercial banks operate in a market.
They will adjust the price of their products according to supply and demand.
Reserve Bank Governor Philip Lowe encouraged home loan customers to shop around for the best deal.
Ms Tindall said the hard truth is that too few bank customers make the effort to look for a better deal.
“Some banks rely on the complacency of [their customers] not to shop, ”she said.
The process of transferring home loans between banks can take up to 4 weeks and involves paperwork and phone calls.
Evidence shows that, with a little effort, many mortgagors could save hundreds of dollars on their adjustable rate mortgage.
This is a significant monthly saving.
Additional savings are also crucial for the economy now, as much of the purchases that currently help drive the economy forward are made possible by households opening their piggy banks.