National Australia Bank raised its owner occupied home loan rates by 0.07 per cent last week and other banks quickly followed. With no Reserve Bank movement in sight and none likely for some time, borrowers wondered if the banks are profiteering.
Banks are simply intermediaries, borrowing from one group of people and lending to another, to make a profit on the margin in between. Australian banks borrow around two thirds of the money they need to fund their lending from depositors.
The other third is borrowed in overseas money markets. The Reserve Bank’s decisions influence rates here but they have no effect overseas. International money markets are free markets not controlled by any central bank.
If rates in those markets rise the cost of funds to Australian banks rise and mortgage interest rates must go up. That is what happened last week. The ultra-low interest rates of recent years are ending.
The US Federal Reserve has raised rates twice already and foreshadowed more increases this year. The European economy is improving, causing market rates to edge up. The negative and zero rates that made headlines last year are disappearing.
Inflation is slowly reviving and will cause central banks to lift rates, even in Australia next year. Our banks must also now hold more reserves against loans so they are keen to increase their retained profits.
To do so they have used every justification to raise rates. For example last year the Reserve Bank said it might enable more first home buyers to enter the market if investors were charged higher interest rates, as they were twenty years ago.
So the banks quickly raised loan rates for investors. Not only did they hike rates on new loans, they also jacked up rates for existing investors. It is difficult to see how charging existing borrowers more will help first home buyers, but it will help bank profits.
The strategy worked so successfully with so little public protest that the banks doubled down on it last week. With NAB owner occupiers have to pay an extra 0.07 per cent but investors have to pay an extra 0.25 per cent. Westpac raised its rates for most investors by 0.28 per cent.
The coming higher rates will squeeze many borrowers. Those who don’t plan to sell their home in the next few years should consider locking in a fixed rate for a long term.
Investors who are considering buying property in Sydney, Melbourne or Brisbane should drop the idea. Values have probably peaked for a while with interest costs rising.