Beware the fixed rate mortgage reset

Earlier today I showed how fixed rate mortgages have ratcheted up, rising by 14% (1 year) to 45% (five year) since bottoming last year:

Mozo fixed mortgage rates

Now Citi banking analyst Brendan Sproules is warning that average mortgage repayments could jump by between 25% and 35% as special home loan deals reset:

While fixed rates protect borrowers from higher repayments, blunting the initial effect of rate rises, when fixed rate loans expiring in the second half of next year roll over, the annual interest repayment of around $27,600 on an average $620,000 mortgage at a 2 per cent rate would jump to an annual repayment of $34,600 assuming a variable rate of 3.75 per cent…

Before the pandemic, around 60 per cent of new mortgages were on variable rates and 40 per cent were fixed. But this flipped to around 80 per cent of new loans being on fixed rates during last year. A relatively large amount of banks’ overall mortgage books have been originated in the past 18 months, as refinancing surged.

“Here lies the conundrum for Dr Lowe,” Mr Sproules wrote to Citi clients over the weekend. “If the RBA raise rates too fast, 40 per cent of the book might be set for a rude shock when their fixed term (typically two years) expires.”

CBA head of Australian economics, Gareth Aird, made similar warnings last month:

The fixed rate home loan expiry schedule means that over the next two years a very significant proportion of home loans will expire (see chart below for the CBA fixed rate loan book expiry profile). Based on CBA’s fixed rate home loan expiry schedule and share of the market there is likely to be around $A500bn of fixed rate mortgage loans expiring in Australia over the next two years.

As shown in the next chart, the median economist is tipping the cash rate to rise by around 1.25% by 2024, whereas markets are tipping rates to rise by around 2.5%:

Currently, the average discount variable mortgage rate is tracking at 3.45% – well above the fixed rates taken out earlier in the pandemic:

Thus, if economists and/or the market is correct, many fixed rate borrowers will face skyrocketing repayments when it comes time to refinance. In turn, the increasing repayment burden (for new and refinancing borrowers) would hammer house prices, and dramatically slow the economy.

For these reasons, I cannot see the RBA lifting the cash rate by more than 1.0%, since the impact would be too severe.

Therefore, expect shallow rate rises and not until the end of the year, given the the mortgage market is already tightening independent of the RBA.

Unconventional Economist

Comments

  1. BoomToBustMEMBER

    There is to much focus on interest rates alone, inflation is causing significant jumps in costs, from food to fuel and everything else. Budgets are already under immense pressure. I’m already told that one of the main reasons of a rental shortage is landlords are selling people are selling there properties and renting rather than purchasing another. The reason why are unknown, but talking to a few people I believe people are already on the edge of affordability for their mortgage, and with rising costs and rising rates they are seeing the writing on the wall and selling quickly. I believe this trend will only continue which will cause massive pain in rental land.

    • In Sydney I know a lot of people who sold up and renting for a bit but outside Sydney in reginal areas.
      There was a huge exodus of people to the central coast, south coast and even up to northern NSW coast near Byron.
      I thought that would put less strain on the rental market here but no.
      One thing to note is that dwelling approvals are down 24% on the year nation wide.
      The number of approvals is trending back to 2013 levels.

  2. Goldstandard1MEMBER

    When you leverage to the max, any dint in dospoable income will knock you over. Just the rise in food and petrol might be enough (with no wage rises). Oh and share market declines which are already killing many-and we probably ain’t seen nothing yet.

  3. Too much econobabble being thrown around as fact. Get back to basics.

    What would happen if govt mandated a different price? For example a litre of milk costs approx $1. This is the price that has been set by buyers and sellers in the market created by govt, by property rights, and all the participants actions.

    What would happen if govt mandated the litre of milk will cost $3 by law? Would this harm “the economy”? Would this slow the economy? Would this grow the economy?

    The effect would be that consumers would lose $2 (per litre) and would be forced to reduce spending on other consumption. That would be bad for the economy and would slow the economy? Right?

    But milk producers would get this extra $2 and would be able to increase their spending on other consumption. That would be good for the economy and would grow the economy? Right?

    So it appears that the govt mandate would basically transfer wealth from one group to another and have no net effect. Right? Wrong. The higher price would cause consumers to buy and enjoy a lesser quantity of milk. This lost joy has no offset. Only if there was some unpaid “external” cost associated with milk production can we claim a benefit.

    For example if each litre of milk also damaged the environment in some way that is not priced-in to the product. In that case the price rise to $3 would reduce consumption and save the partially save the environment. In this case we could try to compare the lost buyers joy against the saved environment and make some judgement about the net benefit.

    Milk is a fairly simple example. Once you have a good understanding of that, you can move on to more complex examples, and maybe even move on to interest rates.

    • ParrottMEMBER

      Yes one group (people with bank deposits) would benefit while another would be worse off (those with mortgages). But overall Australians pay a lot more in interest to banks than they receive. So there is a ‘net effect’ to households. This is one reason why the RBA will always favour borrowers when push comes to shove.

      • The whole thing is a net drain on consumption as a $ spent on non productive interest repayments is a $ not spent elsewhere in the economy. The bank deposits thing only stands up if the person selling and pocketing the profit has no intent to buy back into the same inflated market. The only way to win in this game is to add value to an existing property and increase its value beyond the original unadjusted market value (renovation, sub division, new build etc). You either add value or you exit the current market (suburb, state, country) and start in another market with different dynamics, i.e. boomers moving from Sydney to SEQ.

        Banks are generally the only ones who win as the pile of debt grows and their interest receipts grow proportional to that volume. We have the most profitable bank in the world because they make a defined 1-1.5% on a growing pile of relatively low risk (houses) debt.

    • Yes, most economic changes have zero impact when you look at a “first-order” approximation; to see an impact, you need to look at a second-order approximation. In the 1980’s the price of milk WAS fixed by the government, and the system worked quite well. “Dairy Farmers” used to be a cooperative, but its members were persuaded into a rather disastrous restructure by some fast-talking accountants in the early 2000’s. They stuffed a hand grenade down their own pants, and waited for the pin to be pulled.

  4. Agree; no one in the developed world is raising rates and even if they tried they will have to put it back down.
    Most will just jawbone and delay until they don’t have to do anything.
    1 year aussie bonds doesn’t seem like it really wants to go much higher than 0.8
    Even the US where inflation and general indicators are running more hot seems to top at 1.2
    We are about a week away from yield curve inversion on the 10-2
    It’s risk off. The government might even throw some more stimulus check sat everyone.

  5. The banks are raising rates. People borrow from the banks. People are now over leveraged after 2 years of instability and lockdowns. A lot are rushing for the exits in property. It’s the late 80’s. You just don’t want to be late.