Why Fixed Rates Have Been Rising, and are Likely to Keep Rising

Here’s an important point to remember about home loan interest rates: mortgage lenders are influenced by the Reserve Bank of Australia, but not controlled by it.

When the RBA increases or decreases the cash rate, lenders tend to change their home loan rates as well, although not always by the same amount and not always immediately.

But lenders are independent of the RBA, so they’re free to make what are known as ‘out-of-cycle’ rate changes, or changes that occur even when the cash rate is on hold.

This point has become increasingly relevant over the past year, because, even though the cash rate has remained at a record-low 0.10% since November 2020, lenders have been moving their home loan rates up and down.

Between November 2020 and October 2021, the average interest rate for new owner-occupied loans (see the blue line in the graph below) fell from 2.62% to 2.37%. Since then, it’s been climbing month after month – the average interest rate for January 2022 (the most recent month for which the RBA has released data) was 2.50%.

For variable loans (see red line), average interest rates have steadily fallen from 2.85% in November 2020 to 2.52% in January 2022.

But the story has been different for fixed-rate loans:

• For loans fixed for three years or less (see grey line), interest rates fell from 2.16% to 1.95% in May 2021; since then, they’ve increased to 2.43%
• For loans fixed for more than three years (see yellow line), interest rates fell from 2.06% in November 2020 to 1.99% in February 2021; now they’re 3.07%

So even though the cash rate has been on hold since late 2020, fixed rates have been increasing for about a year now.

Why fixed rates have been increasing

Retail service stations buy hundreds of thousands of litres of petrol at a time from big wholesale suppliers, and then on-sell the petrol to consumers. But instead of forcing us to buy from them in bulk, service stations allow us to buy a little bit of petrol at a time. They also mark up the price, so they can make a profit.

Fixed-rate home loans work the same way:

• Retail lenders (like the big four banks) buy money in bulk from wholesale funders (which are often offshore institutions)
• Lenders divide that money into small portions (home loans) and on-sell them to us
• They charge us a higher price than their funders charged them

Mortgage lenders, just like service stations, increase their retail prices when they’re forced to pay higher wholesale prices. And that’s what’s been happening here – Australian lenders have been paying higher prices for the fixed-rate packages they’ve been buying from their funders.

So why have these funders been raising their prices? Because their costs have also been rising.

Big wholesale lenders get much of their funding from selling bonds. (A bond is a bit like a term deposit: the bond buyer hands over their money for a set amount of time, and then, at the end of the term, gets all their money back, plus interest.) Bond yields have been rising, which means the funders selling the bonds have been forced to pay higher interest rates to the buyers of those bonds. The reason bond yields have been rising is because many central banks have been, and are expected to continue, raising their own cash rate – effectively, making money more expensive.

Another reason Australian lenders have had to pay more for their funding is because the Reserve Bank stopped subsidising their costs. In March 2020, at the start of the pandemic, the RBA introduced a temporary emergency measure called the Term Funding Facility (TFF), which offered low-cost three-year funding packages to lenders. The TFF ended in June 2021.

Why fixed rates are likely to keep increasing

Fixed rates are likely to keep increasing, even if the RBA leaves the cash rate on hold for the rest of 2022. That’s because central banks around the world are continuing to raise their official interest rates, and because the markets have priced in future rate rises.

In March, the US Federal Reserve increased its cash rate for the first time since 2018, by 0.25%, and has hinted it will hike several more times this year.

Wholesale funders are having to pay more for their money; these increasing costs are being passed on to Australian retail banks; and those lenders are passing on their increasing costs to us.

The RBA has made it clear it will increase the cash rate sooner or later – it’s a question of when, not if. When that happens, mortgage lenders will push up their home loan rates even more.

Interest rates will remain low for the foreseeable future

That might sound worrying, but it shouldn’t be.

While fixed rates (and home loan rates in general) are likely to increase, this will happen from an incredibly low base. Mortgage rates aren’t going to be high anytime soon; instead, they’re likely to increase from very, very low to merely very low.

Borrowers should budget for future rate rises, but should not be alarmed.

Wondering if you should take out a fixed-rate loan, or refinance from fixed to variable? Shore Financial can explain the pros and cons. To discuss your options, call us on 1300 416 700, email us on info@shorefinancial.come.au or fill in this online form.