I have certainly had my fair share of trying to explain why fixed interest rates are what they are today when it comes to Equipment Finance or any Fixed Rate product for that matter. Too often fixed rates for equipment or fixed property loans are compared to the official cash rate or the honeymoon home variable rate. That would be ideal for all of us but not reality. I thought it was timely that I put my fingers to the keyboard and put something out there to try and shed some light on it all.
Generally speaking, banks lend to home purchasers, credit card users and businesses. Banks source their funds from customer deposits, the wholesale market and securitisation. These funds come at a cost and depend on a range of factors including the cash rate, competition, international events, the bank’s own credit rating and the availability of funds from the wholesale market (both domestically and internationally).
Since the Global Financial Crisis (GFC) began in late 2007 the banks cost of funds have increased over and above what was previously considered the norm when it comes to the price of fixed rate funding today. This cost increase is primarily due to less investors willing to make funds available for the banks to borrow, and that in turn forces the price or cost to borrow higher (bank margins are a discussion for another day).
Generally speaking Bank Bills are the cheapest form of short term funding (up to 180 days) for business finance. The published bank bill rate does not include the banks margin. Depending on what you use the money for will determine the margin a bank will apply taking into account such factors as term, strength of client, and supporting security. When we look at longer term rates say, 3 and 5 year money, we start to look at what is called the Swap Rate as guide to what bank’s cost of funds are doing.
When it comes to equipment finance we are still very fortunate in the way in which banks lend money. By this I mean when compared to arranging finance for a house or commercial property you are required to come up with 20-30% deposit before the bank will lend the money + all the associated legal and government costs associated with that purchase.
In contrast, equipment finance more often than not is 100% financed (i.e. no deposit). The irony here is that whilst a deposit is required on property finance and property is considered an appreciating asset the reverse applies to equipment. From the moment a new piece equipment or motor vehicle is delivered the value drops by at least 20% in most cases and continues to slide until it reaches a stable market value. The risk factor for a bank when lending on equipment dictates that their return on money will need to be higher than that on a property loan due to the risk factor. The secondary market for a home is much more buoyant (less risk) as everybody needs a home whereas not everybody needs a second hand piece of equipment. If the shoe was on the other foot would you be asking for the same return for these two different types of investments.
Another factor contributing to why interest rates differ between home loan and equipment finance rates, the fact that the money is sourced from different channels by the banks to on-lend to the business community. Home loan funding is mostly done on a variable rate which is funded on day to day, month to month, quarter to quarter funding programs. Equipment rates however are based on medium to longer term funding programs and the rates on equipment are on a fixed rate and a fixed term structure. This method gives rise to why the rates are higher on this fact alone let alone where the bank sources it money from. Interestingly, the Commonwealth Bank website currently has on offer a term deposit rate of 7% for a 5 year term. This means that the bank would need to lend out at rates of around 9% + in order to meet its obligation on that term deposit and make a return.
I am consistently seeing 5 year fixed rates for commercial property advertised around the 8.95% mark so equipment finance rates in the 9% + range is looking very attractive when all is said and done.
For whatever comfort the following comment is worth, it is interesting to note that according to the statistics provided to the Australian Bankers Association “data to early 2009 shows that bank’s interest rate margins remain at low levels. In late 1995, bank margins were almost 4% and are now 2.15%.” It would appear in more recent times that this margin is now on the way up again.