Tuesday, November 09, 2010

"Go on, charge what you like" - the Aussie mortgage contract

We're special

Australian variable rate mortgages are unusual and unconscionable and should be banned in order to even the balance of power between banks and their customers according to a leading finance expert.

Professor Kevin Davis, research director of the Australian Centre for Financial Studies will put the proposal in a submission to the Senate inquiry into banking announced in the wake of this season's big bank profits.

"Australian home-buyers sign a contract which gives the bank the right to change the interest rate whenever and to whatever it wants," he told the Herald.

"I'm not a lawyer, but it seems to me completely inappropriate that a buyer should be allowed to sign a contract where they give the seller the right to charge whatever price it wants."

"In fact I know of no other contract like it. Foreigners find it amazing"...

Professor Davis has produced an American-sourced list of twelve leading economies in which only two - Australia and Germany - have variable rate mortgages predominantly completely variable at the bank's discretion.

The others have so-called "indexed" variable rate mortgages in which the contract stipulates the number of points above an indicator rate the bank will charge.

"In Australia you would legislate that loan contracts could not contain a clause giving the lender the discretion to change the rate," he said.

Such a law would have prevented the Commonwealth Bank imposing the outsized rate increase it announced on Melbourne Cup day.

"The rate would be set in relation to an indicator rate, say the bank bill swap rate for a certain number of years," Professor Davis said.

"After say 3 or 5 years it could be reset or the customer could move to another bank without an exit fee because the bank would have recovered its costs."

Mr Davis says our present system encourages the banks to take risks knowing they can recoup losses from their customers.

"Suppose one of our banks got downgraded from a AA to B. What would happen at the moment is they would just increase the margin on their mortgage rates to cover the extra costs they would face, whereas that risk should fall on the mangement and the shareholders."

The Melbourne University finance professor has found an unlikely ally. Unbeknown to him Greens MP Adam Bandt is about to introduce a private members bill that would make it obligatory for each bank to offer such a product. Davis would make it compulsory, for variable rate mortgages.

Bankers Association chief Steven M├╝nchenberg is also sympathetic. While opposing compulsion he says he his members are already looking at the Green's proposal for each bank to offer such accounts as an option.

"We are aware that Australia is unusual and we are not sure why. It would be for historical reasons, not a conspiracy," he told the Herald.

Such contracts could work, but "it would be hard to work out what the reference rate should be, it shouldn't be the bank bill rate because mortgage funds also come from overseas".

It has now been a week since the Commonwealth Bank's 0.45 per cent Melbourne Cup Day hike, and none of its big three competitors have responded, the longest delay in reacting to a Reserve Bank hike on record.

Variable at the bank's discretion?

Variable mortgages worldwide

United States NO
Japan NO
Korea NO
Canada NO
France NO
Spain NO
Holland NO
United Kingdom SOMETIMES
Gemany YES
Australia YES

Research Institute for Housing America 2010

See Kevin Davis, Mortgages: Time to Re-Design, November 5, 2010

Published in today's SMH and Age

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