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Is it time for an Australian 30-year fixed rate mortgage?

The last few years have provided an enthralling comparison in the many facets of life between Australia and the USA. From a pandemic perspective, the Australian mortality statistics speak for themselves in our appropriate handling versus the fractured attempts by our strategic allies.

Australia's sensitivity to interest rates

From an economic standpoint, however, the resumption of 'normal' monetary policy may be an area where 'the land of the free' has a structural advantage to emerge victorious.

One of the many issues that confront central bankers worldwide is that in the face of surging inflation, low unemployment, and the strength of their currency (for those that care), they have at their disposal one lever to exert force on their respective economies.

Raising rates to help cool the economy makes sense. It increases the cost of borrowed capital for all and sundry, quelling frothy asset speculation both at a household and industry level. It can help to dampen government spending and is helpful to cast a pallor over excitable and speculative projects that need reconsidered using a rising risk-free return.

What's more, when viewed at a distance, this primary mechanism offers simplistic answers to the economic problems of the day. It is hard not to like it.

As past Governor of the Reserve Bank of Australia (RBA), Glenn Stevens remarked in 2008, the cash rate has been described as a 'blunt instrument' to exert influence over the economy.

So does it have the resolution to steer the next century's fast-moving and highly levered economies? Well, that can depend on how these economies are geared.

Similar and yet so very different

Australia and the US (like most developed countries) share similar traits concerning homeownership, as shown below:

 

Sources: policyadvice.net and abs.gov.au. *Data provided does not equal 100%.

Where the similarities end, however, is with the predominance of the US fixed long-term (usually 30, sometimes 15 years) home loan versus Australia's obsession with either short-term fixed or variable rate mortgages:

 

Sources: bankrate.com and abs.gov.au. *Data provided does not indicate fixed rate term length, however 2 years is predominant.

The US is the only country in the world in which the 30-year fixed rate residential mortgage is the dominant home mortgage product. The ability for Americans to easily access relatively cheap long-term money at a fixed rate serves several purposes.

From a borrower's standpoint, a fixed rate mortgage (FRM) allows a reliable and standard repayment, fixed for the considerable life of the loan. This may account for the higher percentage of 'free and clear' owners in America over Australia, as it could well be the only mortgage they ever need. A notable feature is if the borrowers situation changes after a few years and the home needs to be sold, there is no prepayment penalty for closing the loan.

From a lender's standpoint, the situation is a little less rosy. Just the thought of locking in a market acceptable rate for 30 years would be enough to give an Australian banker heartburn. Enter government intervention. The one critical defining difference is the ability of banks to shift this risk onto a willing buyer, in this case, the US government-backed Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). With the interest risk removed, these products suddenly become commercially viable to the distributing banking sector.

In Australia, it's a different story. For those banks willing to offer 'extended' fixed terms, usually only up to 10 years, the internal interest risk mitigation usually means unenticing rates to the market. On top of that, borrowers are faced with severe penalties if they need to move house and 'break' the term if interest rates have fallen. Without the backstop of a federally-supported entity to remove this risk, it isn't easy to see the extended fixed-rate market maturing properly here.

So, what would motivate the Australian government to bother with such an initiative?

Structuring for a sharper instrument

The quantum of the impact that central bank rate rises have on the general population can differ materially depending on the predominant mortgage structure.

As we see today, central banks globally have moved to restore cash rates from their pandemic lows, with notable and often significant upward movements. Leaving aside the great lifts on a percentage basis owing to the low base effect, these changes are flowing rapidly and by design to households with mortgages.

In the US, this means a real impact on new mortgages at the margins but leaves the remaining loan book largely unharmed. A benefit of this outcome is especially relevant when you consider the younger loans where recent first home buyers are borrowers are often the primary risk case for severe property price downturns.

In Australia, due to the prevalence of variable loans, be it first home buyers or not, the effect of rising rates is felt immediately by most with a mortgage. The ability for the RBA to create ‘mortgage stress’ comes at a much lower level when compared to the US, especially given the enormous growth in personal debt levels over the last two decades.

Their unique mortgage structure allows the US Federal Reserve a lot more 'headroom' for raising rates to meaningful levels when looking to address the many other components of their financial system. By reducing the direct impact on the real estate coalface, there is now an opportunity to hone cash rate pressure to areas such as commercial and government demand without the risk of destabilising the whole economy in the process.

In Australia, however, the omnipresent risk of suffocating demand on a household level while trying to reach meaningful cash rate levels for other areas of the economy is genuine. If the RBA wants a sharper stick, it may need to consider funding an Australian ‘Fannie Mae’ (feel free to offer another name in the comments).

The future indicates that increasing debt loads are almost a certainty, and it brings the need for a reflection on whether the present structure in Australia offers the best fit for the main instrument available to our central bank. As we emerge from a decade of expansionary monetary policy into a tightening one, the time is nigh to consider extended fixed-rate mortgage alternatives.

 

Tim Fuller is Head of Wealth at Strata Guardian. This article is for general information only and does not consider the circumstances of any individual.

 

14 Comments
Kevin
July 23, 2022

Do you want your super fund to get you high returns,or would you want them to get you low returns The difference between 9% and 4.5% is frightening.At 9% you double your money every 8 years,at 4.5% you double your money every 16 years Over a 30 year period that is terrifying. While they would not have all of the fund in mortgages even a reduction of 1 to 2% in returns over that 30 year period is something you want to avoid. Personally I wouldn't be looking at the US market to solve perceived mortgage problems.But each to their own.

Dudley
July 21, 2022

No need for any mortgages where real interest rates are large.

Individuals would save rather than buy homes until they had full purchase price saved - reducing demand for homes reducing home prices - reducing time to outright home ownership.

However, the world prefers negative real interest rates.

C
July 20, 2022

no. I want to be able to pay off my mortgage much quicker than 30 years when I have the financial capacity to make extra payments. variable rate loans permit that.

Tim Fuller
July 21, 2022

Good point C, and an area that I didn't mention in the article.
US 30 & 15 year fixed rate mortgages actually allow extra repayments without issue, providing you are out of the 'prepayment penalty' period. From what I have seen, the penalties only apply in the first few years of the mortgage, essentially to cover origination costs to the lender. Unsure of the redraw facilities available, however.
From an Australian point of view, there is a fair bit of 'have your cake and eat it too' compared with our local offerings.

Bill Brown
July 20, 2022

Tim the US home loan system has always appealed to me but I'd suggest that it has limited if none chances of getting up in Australia – the banks make too much at home loans and give too much money to political parties to let that happen. They still pack a lot of punch even though the coalition has left. You may recall that the banks urged the government to resist a Royal commission for years, and suddenly changed their mind, and were then allowed to write the terms of reference of the Royal commission so that banking came out with little damage. Can we have another article on what I understand to be the tax deductibility of interest on home loan mortgages in the US?

Tim Fuller
July 20, 2022

You make some good points Bill. Still, if a 30-year fixed at 4.5% was launched tomorrow, I think there would be a market for it. The missing link is federal backing. It's no secret that there is implicit support by both major parties to protect the housing market so there should be a solution that can keep the banks happy as well. Brokers on the other hand....
Let me look into your request re tax and US mortgages, thanks for the suggestion.

Kevin
July 20, 2022

Where does the money come from Tim.Reading the CBA annual report they have $580 billion lent out in mortgages.They have deposits and other public borrowings of $766 billion ( note 4.1). NIM is 2%.

Total assets are $1.091 trillion.Total liabilities are $1.013 trillion,they run on the smell of an oily rag.

There are always markets for the I will be able to pay less things.There is a shortage of markets for the I am prepared to accept a lower return on my investments.

The average dividend payment across the shareholders is $2200.Should they take less?.The super funds that own the vast majority of shares should be happy with a lower return?

Everybody has wonderful ideas of I will reduce the money coming out of my pocket,all problems are then solved.Where are the ideas of how to make this happen?
During the GFC if I remember correctly Fannie Mae and Freddie Mac went bust and the US govt had to produce a very large rescue package

Glamourboi
July 23, 2022

Why can’t the superannuation market supply fixed cost mortgages.

SJY5280
August 30, 2022

It's basically a government subsidy. This is why it works. I'm a dual citizen (US and Australia) and have had mortgages in the US and Australia. Another point I want to emphasize and bring to the conversation (to be clear) - there is no prepayment penalty on ANY US mortgages (30 year, 15 year, or adjustable). Adjustable mortgages are usually no longer than 5 years. Most people refinance to a fixed before the adjustable period ends.

Kevin
July 20, 2022

I didn't see the last bit.Things may have changed but the US had tax deductability on owner occupied loans,various states may have had different rules.I don't think it was fully deductable but I could be wrong.I think this also led to CGT on owner occupied property.

The UK had something similar in the 1970s,called MIRAS ( mortgage interest relief at source).I think it was only on the interest for the first £30K of a mortgage and the tax on wages was slightly reduced for people that had mortgages.
I don't think it is any good cherry picking things from other countries and not wanting the full bundle.

Kevin
July 20, 2022

Have a Google of MIRAS. Brought in in 1983 and abolished in 2000 as a middle class perk. Mortgage brokers used it to sell endowment mortgages, that was a big scandal. Don't cherry pick.

K Bailey
July 20, 2022

Don't we have the Future Fund as a big pot of capital with long duration? A good spot for mortgaged backed securities? Seems that may be our 'Fannie Mae'. We can jazz up the name a bit though - 'lender of last resort' (LOL.R) sounds appealing.

Tim Fuller
July 20, 2022

It's worth having the conversation about the Future Fund's potential involvement KB, similarly for the big super funds. The (nick) name is a challenge, 'buyer of last resort' (BOLR) has been tarnished recently for some.
Perhaps the 'Commonwealth Originating Bank Bond Authority' (COBBA)?!

Kevin
July 20, 2022

The problem is still the same.My super fund has returned an average of 9% since 1985 ish.Along with all funds it has a wide variety of returns over the years.Money is needed the answer is always"get it from the super funds'.
Where are these funds that are prepared to accept lower returns for a fixed 30 year mortgage.

Before the present pull back the Future fund had $200 billion in it approx.Scratching the surface for mortgage demand?

 

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