Fixed interest loans could help protect borrowers

Greater use of fixed interest and adjustable rate mortgages could help reduce the risk burden on Australian home loan borrowers, according to Australian Centre for Financial Studies research director Professor Kevin Davis.

Under Australia’s current mortgage system banks are free to adjust interest rates at their discretion, exposing borrowers to excessive risk, but banks currently have little incentive to introduce more equitable options, Davis said in his paper Mortgages: Time to Re-Design.

In a fixed margin loan the interest rate is set at a fixed margin over a relevant indicator, such as the official cash rate, so the borrower is still exposed to general interest rate moves but not to discretionary changes by the bank — although additional complexities would be involved in increasing the use of these loans.

Because banks are unlikely to make any changes to address issues in the mortgage system, Government leadership is required to bring mortgage loan contracts into line with the reality of 21st century financial markets, Davis said

Variable rate home loan rates averaged around 180 basis points higher than the cash rate prior to the global financial crisis, but have now increased to 290 basis points higher, Davis said. While there have been significant changes in funding costs, a question remained over whether borrowers should bear the entire burden or whether banks should be prepared to take a hit to profits, he said.