It's game on in real estate

When mortgage broker Sheyne Walsh sits down with his clients, he gets them to focus on the likely home-loan rate in a couple of years, not the rate today. The joint head of lending at Centric Lending Services says he is convinced interest rates will rise by a couple of percentage points or more over the next two years.

"Banks are still offering discounts of up to 0.7 per cent on bigger loans and packages [home loan plus transaction account and credit card]," Walsh says. "Borrowers can get their money at a little over 5 per cent today.

What we ask them to do is look forward. If their rate goes to 7 per cent, could they still afford it? Can they put some extra into the mortgage account or a savings account to create a buffer? Do they need to fix? Should they go interest-only for a few years?

With house prices on the rise, interest rates likely to rise, the first-home buyer grant winding down and the economy getting stronger but still fragile, the home-loan market is in a state of flux.

Bank economists believe rates will start to rise early next year. The senior rates strategist at ANZ, Tony Morriss, said recently: The probability of monetary policy tightening before the end of the year is rising. At this stage, we believe the RBA will need to see further evidence on how the household sector performs to make this decision. Should retail sales and employment data continue to hold firm in the coming months, then there is a serious probability that rate hikes could commence from November.

FIXED OR VARIABLE

ANZ predicts the official cash rate will move from its current 3 per cent to 3.75 per cent by September 2010. Westpac expects the cash rate to move in the March quarter and reach 4 per cent by the end of the year.

The most bearish of the big banks on rates is the Commonwealth, which expects rates to remain on hold until the first quarter but then rise quickly, to 4.75 per cent by the end of the year.

Walsh says: We recommend clients start building a buffer by making extra payments on the loan or putting some extra money into a savings account.

A number of clients are looking at fixed rates but it is hard to see how you can win with fixed rates where they are now. If you are paying a little over 5 per cent on a discounted standard variable rate now and rates go up to 10 per cent over the next five years, your average rate over that period will be a little over 7 per cent. Five-year fixed rates are higher than that now.

But if you think rates will get to 10 per cent and you can't afford the repayments at that level, then you should work out the point at which you have to move out of variable and into fixed.

Australian Bureau of Statistics housing-finance figures show demand for fixed-rate home loans has risen sharply over the past few months. All the talk of imminent rate rises has had an impact on borrowers.

Fixed-rate loans made up 8 per cent of all dwellings financed in June, up from 6.2 per cent in May, 4 per cent in April and 2.5 per cent in March.

Demand for fixed-rate loans reached a low in December, when only 1100 were written  just 1.9 per cent of dwellings financed that month.

GAP GROWS

Based on a comparison between variable and fixed rates, it may not be a great time to fix. Average three- and five-year fixed rates bottomed in March and have risen quite sharply since then.

Three- and five-year bond and swap rates moved up in recent months, as investors in the financial markets factored in economic recovery and the possibility of inflation. Fixed-rate mortgages have responded to this move.

The gap between variable rates, which are below 6 per cent, and fixed rates (five-year rates are about 7.5 per cent) is the widest the market has seen since 2002, according to researcher Infochoice.

The average three-year fixed rate of the big four banks peaked at 9.42 per cent in July last year. It reached a low of 5.66 per cent in March and is currently 6.74 per cent.

The average five-year fixed rate of the big four peaked at 9.39 per cent in July last year. Its low was 6.45 per cent in March and the average now is 7.45 per cent.

The average standard variable rate for the big four is 5.78 per cent but discounts can often be negotiated.

BEST DEALS

Banking industry researcher Canstar Cannex says one of the best deals at the moment is the package offer. Package discounts are between 50 basis points and 70 basis points.

Even with an annual fee of as much as $395 on a package, borrowers can make savings by bundling products, thus cutting out other account fees and reducing interest payments.

Taking the example of a $350,000 loan at 5.78 per cent (the average of the big four), the borrower would pay $20,230 of interest a year, a standard $100 mortgage-servicing fee, a $50 credit card fee and $60 in transaction account fees.

By choosing a package, the borrower would pay $17,780 of interest on the discount rate of 5.08 per cent plus the average package fee of $350. The total cost is $18,130 and the saving is more than $2000 a year.

In a recent review, Canstar gave five-star ratings to ANZ's Breakfree Package, Commonwealth Bank's Wealth Package and St George's Advantage Package (also available through BankSA).

The official figures show big banks still dominate the mortgage market but the strong demand for home loans has encouraged some smaller lenders to return with aggressive offers.

NON-BANKS

Broker Mortgage Choice is doing more business with regional banks and non-banks. Loans advanced by the big four accounted for 75 per cent of Mortgage Choice settlements in the December quarter but came back to 71 per cent in the March quarter and 60 per cent in the June quarter.

The share held by other banks rose from 21 per cent to 33 per cent over the same period. Other banks on the Mortgage Choice books include Adelaide Bank, AMP Banking, BankWest, ING Direct, Macquarie Mortgages, St George and Suncorp.

Building societies and other lenders also gained share. Others on the Mortgage Choice books include Collins Securities, FirstMac, GE Money, Keystart Loans, La Trobe Financial Services, Maxis Loans, Over Fifty Group and Rams.

The chief executive at Mortgage Choice, Michael Russell, says some of the lenders doing more work with the group's brokers are Suncorp, BankWest, Heritage Building Society and Newcastle Permanent Building Society.

He says some lenders have reactivated more aggressive products. For example, BankWest is doing more marketing of its Rate Tracker Home Loan, which offers a discount to the average variable rate of the big four. With signs of more competition in the market, borrowers should do more shopping around.

PROPERTY PRICES

The final piece of the puzzle is the outlook for the residential property market. According to the residential property research group RP Data-Rismark, the average price of a home rose by 5.9 per cent across the country in the seven months to the end of July.

Darwin had the biggest rise, with house prices up 10.8 per cent in the seven months to July. Melbourne was also a strong performer, with prices going up by an average of 8.5 per cent in the period.

Sydney was up an average of 6.6 per cent, Canberra 5.4 per cent, Brisbane 3.8 per cent, Perth 2.5 per cent and Adelaide 1.9 per cent.

RP Data says the growth is widespread, taking in expensive suburbs as well as first-home buyer territory.

The common view among economists is the upward momentum is due to low interest rates, generous grants to first-home buyers and tight rental markets.

INCLINED TO BUY

The head of property research at ANZ, Paul Braddick, says another important factor is that reasonably conservative lending practices in Australia mean there has been no US-style housing collapse. The real estate market is moving back up off a solid base.

One question is whether demand from first-home buyers will weaken once the Federal Government's first-home buyer grant cuts out in December.

Braddick says this may occur but other factors will help maintain the momentum. Because of a shortage of housing (a result of reduced building activity and high immigration numbers), the rental market has tightened. According to ANZ, real rents rose by 4 per cent in 2008.

Lower interest costs and higher rents are tilting the rent-or-buy question in favour of buying, regardless of the availability of grants. At the same time, the low rates and rising rents are a buy signal for investors.

INVESTORS RETURN

The 2009 edition of Mortgage insurer Genworth Financial's Mortgage Trends Report, released in late July, confirms investors are back in the market.

Forty-three per cent of respondents to the Genworth survey said it was a good time to buy a residential investment property, up from 33 per cent in the 2008 survey.

Of those who thought it was a good time to invest in residential property, 84 per cent said it was because property prices had come down, 78 per cent said interest rates were favourable and 51 per cent said the rental shortage would lead to high rental income.

In June, the economic forecaster BIS Shrapnel published a report in which it said demand from investors and upgraders was growing and would more than make up for any slack as first-home buyer activity started to ease off later this year.

BIS Shrapnel expects prices to keep going up but to move slowly until unemployment peaks early in the 2010/11 financial year. It forecasts a return to double-digit growth in residential property prices in the 2011/12 financial year.

The group is forecasting Sydney, Melbourne and Adelaide house prices to increase by a total of 19 per cent over the three years to June 2012.

Prices in Canberra are expected to grow by 17 per cent, those in Brisbane by 16 per cent, 14 per cent on the Gold Coast, 12 per cent in Perth and house prices in Darwin are expected to grow by 11 per cent.

BIGGER DEPOSITS

Investors returning to the market and home owners trading up or refinancing will notice lenders have tightened their lending criteria in response to the global financial crisis. Last year, lenders cut the maximum loan-to-valuation ratio from 100 per cent to 95 per cent.

Some, including Commonwealth and ANZ, took it down to 90 per cent for new borrowers (95 per cent for established home-loan customers).

Lenders have also imposed a requirement for deposits to include some genuine savings, which means the deposit cannot be made up entirely of Government grants.