Carnival is over for fixed rate home loans
A large group of borrowers have been unimpacted by the RBA’s interest rate hikes because they locked in low interest fixed rate loans, but this is about to change.
One of the complicating things about the current round of interest rate rises is when they will really start to have a big enough impact to turn around inflation.
One of the reasons that things really are different this time is the much higher than normal number of fixed rate loans financed at really low rates during the pandemic.
Usually, fixed rate loans are below 20% of the Australian loan book but due to the sub 2% rates that were on offer during the pandemic period and the $188 billion of three-year loans indirectly financed by the Reserve Bank of Australia, that went as high as 40% of loans written – pushing the overall percentage of fixed loans to about 23% of the total.
That has meant that the strong signals that the RBA has been sending in the form of higher interest rates have not been getting through as clearly to a large group of borrowers that are still paying off their loans at very low interest rates.
The signal has also been muted for borrowers on floating rate loans, which have been running up to two months behind official rate rises in repayment terms.
Here comes the hangover
While those with super-low fixed loans are in a great position for now, the carnival is starting to wind down and a very strong hangover could be about to start.
Most of those borrowers will be making the awkward transition to floating rate loans in 2023, which means almost $500 billion of loans will start to attract rates that are 3% to 4% above what they are accustomed to paying – in other words, their mortgage repayments will suddenly more than double.
It is estimated that two-thirds of the fixed loans taken out during the pandemic will mature during 2023, with another third maturing in 2024.
This delay to feeling the effects of rising interest rates could be one of the reasons why consumer spending has been holding up quite well even as interest rates have been rising, with the signal to rein in spending being delayed by the slower than normal pass through of rate increases.
Savings also propping up spending – for now
Other factors at work include the big pile of savings socked away during the pandemic due to lower spending opportunities and pandemic welfare payments.
The national accounts showed that Australians saved an impressive 17.2% of income during that period while a Melbourne Institute report found that precautionary savings had caused Australian savings balances to be 46% higher than two years ago.
Those savings will be slowly eroding at the moment due to inflation boosted prices, increased travel opportunities and rising bills, but the big cost that has been gradually hitting so many households with floating rate housing loans will in the coming year hit households with fixed rate loans like a tonne of bricks.
As the RBA put it in its latest financial stability review: “Based on current market pricing for the cash rate and assuming full pass-through to variable mortgage rates, most fixed-rate borrowers with loans expiring in 2023 will face discrete increases in their interest rates of 3–4 percentage points when they roll over to variable rates, depending on their current rate and the timing of their fixed loan term expiry’’.
Loans have already run through the safety buffer
An important thing to note about this is that when these fixed loans were being written, banks had to apply a mortgage repayment test that was 2.5% above the mortgage product.
That repayment test has now been totally blitzed by circumstances that were never envisaged back in 2020 and 2021 when the RBA was still predicting official interest rates would remain close to 0.1% until 2024.
All eyes on the RBA for December decision
All of this draws a very strong focus to the RBA’s next interest rate decision which will be announced on 6 December.
Will the RBA be more influenced by its own projections which point to some fairly harsh mortgage and inflation pressures coming to bear on Australians in the coming year or will it shadow the rhetoric of many offshore central banks and continue to fight inflation with hefty rate rises?
Most pundits have the RBA raising rates by 25 basis points on 6 December, but there is still a strong camp that believes a 50-basis point rise is both needed and will be delivered to fight the inflationary pressures both local and imported.
A 50-basis point rise would deliver a harsh message to those lulled into a sense of security by the past 25 basis point rises in October and November and would certainly get people thinking about how festive Christmas should be before the year ahead.
Big risks either way for RBA
There are risks either way for RBA Governor Dr Philip Lowe.
If he plays it safe with a 25-basis point rise, he then faces a white-knuckle ride through to next February’s decision, which will be made after seeing the December quarter’s inflation numbers.
Should those numbers be higher than expected, he would once again be “behind the market” and scrabbling to catch up with other central banks such as New Zealand, which went for a whopping 75 basis point rise in November.
On the other hand, going for a 50-basis point rise in December knowing that a lot of household budgets will already going to be put under extreme strain risks crushing economic growth and hitting consumer spending hard.
It’s a tough decision but 25-basis points seems to match Dr Lowe’s slow and steady actions so far, so we’ll wait and see.