End of Low Interest Rate Cycle ? and Lenders Mortgage Insurance Analysis

With the announcement today (6th Oct 2009) that the Reserve Bank has decided to increase the official cash rate by 0.25% to 3.25%, I thought it would be timely to provide a brief economic update as per below. I have attached RBA’s media release if you wish to read it.

Performance
• The Australian economy's performance over the first half of this year has exceeded expectations with consumer and business spending responding positively to the sizeable monetary and fiscal policies. GDP increased by 0.6% in the June quarter which was a healthy rebound from a 0.7% contraction in the final quarter of 2008.
• While the global downturn has hit wage growth income, disposable income growth has held up strongly. This reflects greatly reduced debt servicing costs and the $20bn cash transfer from the Commonwealth Government over seven months
• The key growth engines for 2010 will be a turnaround in housing construction from declines to a sharp recovery and a substantial acceleration in public sector investment. The strength of housing finance points to upside risks - even with the prospect of an easing in the first home buyers segment

Interest Rates
The market is confident that the RBA will have raised the cash rate by 50bps by the end of this year and that the cash rate will be 125 to 150bps higher by June next year.
- Westpac's forecasting that the rise by mid next year will be more like 50 to 75bps,
- CBA forecast to increase another 150bps by Dec next year
- ANZ forecast to increase another 100bps by Dec next year

On a separate note, this week I would like to discussed about Lenders Mortgage Insurance (or LMI).
Most people we chat to each day will ask on interest rate and application fees, however they always forgot about LMI cost.

LMI is an insurance that protects the lender if borrower default on the loan.

This insurance is required if the borrowing ratio is more than 80% (for full documentation applicants) or 60% (for low documentation applicants).
It will also depend on location of properties too, for example with some lenders any inner CBD postcodes LMI is required if it’s more than 65%. We will discuss more about this in another week.

There are two major LMI insurers in Australia, they are Genworth (part of GE) and QBE. However premiums are quite different across to each lenders even though they may be using same LMI company. This is because each lender’s loan portfolio is different and clients base could be very different too.

Further some lenders have their own mortgage insurance subsidiary company as well (ie self-insured), example like ING, Westpac, ANZ, St George.

LMI premiums will normally depend on 2 variables, one variable is % of borrowing and second variable is borrowing amount. Then this will determine the total cost. Each state may have different stamp duty cost on the LMI (yes another Tax !) and also some may give discount to first home buyers.

Just to give an example of the premiums, say a borrower needs a 90% finance and loan is $300k.
With one lender the LMI will be $4,983 and another lender will be $2,823, which is different by $2,160 ! and both are major lenders.

Over the last 6 months we have noticed LMI premiums have being moving up at the same time maximum borrowing % have been coming down. This could be increase in default rate or maybe LMI provider is expecting interest rate is coming back up and people will be more likely to default.

Although LMI is a once off fee, to my opinion it’s definitely worthwhile to know how much it will cost when doing the loan comparison, especially when interest rate is going up !

If you would like to discuss any of the above, please shoot me through an email and I will give you a call.