Truth behind mortgage cliff fears as Aussies brace for possible interest rate hike on Melbourne Cup Day

Despite catastrophic predictions of the fixed-rate mortgage “cliff” that made headlines for months and stoked fears of widespread defaults and rising delinquencies, household borrowers have so far weathered the interest rate storm.

But with new interest rate pain potentially on the horizon, the outlook for borrowers once again appears uncertain.

According to the latest data from the Reserve Bank, Australia is now more than halfway through a $350 billion transfer from super-cheap fixed rates of roughly 2 percent to more expensive variable rates of around 6 percent.

Many borrowers are still struggling to cover the costs of the increase in repayments, but overall mortgagors are in a good position to continue servicing their home loans.

More than one million fixed rate loans have already switched to higher variable rates, and this number is expected to rise to almost 1.5 million by the end of 2023.

The RBA has embarked on the most punishing round of rate hikes in a generation as it tries to curb persistent inflation. Since May last year, interest rates have risen by 400 basis points.

Households with an average mortgage size of $585,000 are now paying $1,415 more monthly than before the RBA began the current tightening cycle.

But despite the rise in interest rates, defaults and delinquencies are still below pre-pandemic averages, with most borrowers expected to be able to service their higher repayments when their loans mature.

“We’ve seen the culmination of those fixed-rate mortgages expiring,” Cameron Kushner, director of economic research at PropTrack, told NCA NewsWire.

Kushner said that despite pain and a broader decline in household consumption and savings, borrowers are weathering the transition “pretty well.”

“It’s usually the things we don’t see coming that are really problematic – we’ve been talking about this fixed rate mortgage cliff for a number of years, people have had a lot of space and time to prepare for when this would happen,” he says.

Commonwealth Bank, Australia’s largest lender with more than half a trillion dollars of home loans on its books, says delinquencies on loans converting from fixed to variable rates were in line with its broader portfolio

Commonwealth Bank, Australia’s largest lender with more than half a trillion dollars of home loans on its books, said delinquencies on loans converting from fixed to variable rates were in line with the bank’s broader portfolio.

Thirty-day delinquencies for CBA are just 0.92 percent, while 90-day delinquencies are even lower at 0.43 percent.

The RBA gives three reasons for this resilience.

Firstly, the continued strength of the Australian labor market has supported household incomes, providing much-needed funds for repayments.

Second, households have significantly cut back on spending, especially on durable products, freeing up money for the essentials.

Third, the large household savings buffers built up during the COVID-19 lockdowns have also provided much-needed support. Recently, however, the flow of new savings has slowed considerably.

As COVID-19 sweeps the world, the RBA’s strategy at the time of ultra-loose monetary policy, cutting interest rates to just 0.1 percent and doling out cheap loan support has also helped transform the composition of the home loan market.

Indeed, in the past, borrowers with fixed interest rates were considered slightly riskier than borrowers with variable interest rates.

However, with the onset of the pandemic, a significant new group of borrowers emerged with fixed loans to take advantage of exceptionally low interest rates.

As a result, fixed-rate borrowers began to closely resemble the characteristics of traditional variable-rate borrowers, and the performance of both fixed- and variable-rate borrowers began to align.

As a result, fixed-rate borrowers began to closely resemble the characteristics of traditional variable-rate borrowers, and the performance of both fixed- and variable-rate borrowers began to align.

‘At what price?’

However, there is no doubt that many are still facing significant pressures and that the impact of rising interest rates is very unevenly distributed across households.

Sebastian Watkins, chief operating officer of Lendi, owner of Aussie Home Loans, which has loans of almost $100 billion on its books, says while delinquencies are still very low, they are starting to climb.

“There’s a lot of stress and pressure in the system right now… We’ll see some of this pain play out more dramatically in retrospect as more flat rates disappear,” Watkins said.

“Australians are very loyal to their mortgage – there are a lot of things they will stop doing before they stop paying their mortgage.”

“Yes, (repayments) are holding up, but at what cost?”

In her first speech as governor of the RBA, Michele Bullock echoed these concerns, pointing to the grim statistic that one in twenty households with a variable rate mortgage were unable to cover the costs of ‘essential expenses’.

For highly indebted borrowers (those with loans of at least four times household income), Ms Bullock noted that one in four mortgagors were unable to cover costs.

In her first speech as governor of the RBA, Michele Bullock echoed these concerns, pointing to the grim statistic that one in twenty households with a variable rate mortgage were unable to cover the costs of ‘essential expenses’.

These households, the governor said, took advantage of pandemic-era savings, working extra hours or forgoing expenses that would normally be considered essential.

In extreme cases, Ms Bullock warned that households could negotiate hardship assistance with their banks or sell their properties outright.

More pain on the horizon?

So what is the outlook for the further 450,000 loans set to move to variable rates in the new year?

Once again, the RBA considers that fixed rate loans that have yet to be repaid do not appear ‘materially riskier’ than loans that have already been repaid and have already benefited from low interest rates.

“The majority of current fixed-rate borrowers are estimated to have sufficient income to continue meeting their obligations after moving to higher mortgage payments,” the RBA notes.

According to its analysis, the central bank estimates that two-thirds of borrowers who still have fixed-rate loans have savings equivalent to at least 12 months of scheduled mortgage repayments.

This is about the same level as that of variable rate owner-occupier borrowers.

But as the RBA itself admits, there is a smaller cohort of fewer than one in five borrowers who will move to higher interest rates with much lower savings buffers, meaning less than three months’ repayments.

Adding to the uncertainty, new inflation data released on Wednesday that came in above economists’ expectations has increased the likelihood of a rate hike on November 7.

This is the group the RBA will be watching closely.

Adding to the uncertainty, new inflation data released on Wednesday that came in above economists’ expectations has increased the likelihood of a rate hike on November 7.

Bond markets are now pricing in a two-in-three chance that the central bank board will raise the cash rate to 4.35 percent, up from 4.1 percent at the Melbourne Cup Day meeting.

The chance of an interest rate increase by the end of the year now stands at 88 percent.

Every step up will undoubtedly bring more pain, but with borrowers generally staying afloat, the central bank is likely to feel confident that another rate hike is a risk it can afford.