Spreading the risk of rate moves
Mortgage cost averaging could offer one way for larger borrowers to lessen the impact of changes in interest rates.
Thursday, June 3rd 1999, 12:00AM
by Paul McBeth
You take out a mortgage and maybe you fix some, you float some.
However, mortgage broker Kieran Trass believes you can be doing more. Much more.
He's come up with a risk management concept, pitched mainly at property investors with mortgage debt of around $400,00 or above, that he calls mortgage cost averaging. What this involves is dividing up the debt into lots of smaller loans with different interest rate maturities, which Trass says offers less interest rate risk and reduces the stress of deciding whether to fix or float.
As an example, he gives a $600,000 loan with $100,000 on a floating rate, $100,000 on a one year fixed term, the same amount again fixed for two years and so on, so that the borrower is covered against any major movements in interest rates. Trass says this approach may not be cost-effective on smaller amounts, particularly because of redocumentation fees on the fixed loans, and it's at those higher levels anyway "that most people get very sensitive to interest rate movements".
"However, a lot of our clients have mortgages around $210,000, say, and they might put that in three lots of $70,000: one floating, one fixed for three years and one fixed for five, which is at least doing something.
"The usual advice to fix some and float some gives you flexibility and a bit of certainty. However, people can fail to realise that, when you're close to the expiry date of the fixed portion, you're back to exposing your whole loan (to interest rate moves)."
Trass says he first presented his concept late last year and now 35 per cent of his client bases are now using it. General manager of Apex Mortgages (which currently brokers around $10 million worth of loans a month), Trass is a former Business Manager Mortgages for Citibank and a founding member of the Mortgage Brokers' Assocation.
"We deal with a lot of property investors, who often seek an opinion on whether to float or fix," Trass says. "Typically, these clients have a large mortgage exposure to interest rates and the decision can be a very expensive one if they get it wrong.
"As a broker, it is difficult to predict future movements in interest rates. After all, how many of us were able to predict the Asian crisis a year or two before it eventuated, or the significant downward impact it would have on interest rates globally?"
Senior lecturer at Massey University's Centre for Banking Studies Rex Oliver says that while it makes sense for people to have their debt on different maturities, he's not sure how much protection it would offer on smaller amounts.
"It's the same as for people who have term deposits and keep them at different maturities; the flexibility is quite useful. However, while people can spread their term deposits, they still have a tendency to grab the best rate."