- Average short-term fixed loan rates dropped to their lowest point at 1.95% in May 2021.
- Many borrowers will face a 'fixed-rate cliff' when they next refinance their home loan.
- CoreLogic's Eliza Owen, said borrowers may seek a lower interest rate after the peak.
Many Aussie homeowners will soon face a fast-approaching ‘fixed-rate cliff’ when ultra-low fixed-term agreements come to an end, and borrowers need to refinance their loans in the new higher interest rate climate.
CoreLogic Head of Residential Research Australia, Eliza Owen, has identified key considerations for navigating the upcoming changes in the mortgage landscape.
What exactly is the ‘fixed-rate cliff’?
The pandemic saw significant declines in mortgage rates, as the RBA’s stimulating monetary policy lowered bank funding costs and lenders competed for the lowest rates.
The dramatically lowered mortgage rates were particularly seen in debt on ‘fixed’ terms, where repayments are held steady for a set time. Average short-term fixed loan rates dropped to their lowest point at 1.95 per cent in May 2021.
The RBA October Financial Stability Review noted that about 35 per cent of outstanding housing credit was on fixed terms. Two-thirds of this is set to expire within the year.
Ms Owen explains, “When fixed terms come to an end, borrowers will need to refinance their loan. Hence the ‘cliff’ – around 23 per cent of all outstanding mortgage debt will be re-priced over the course of the year, and re-priced at a much higher rate.”
Low fixed-term agreements start coming to an end in April
The figure below shows the chasm between an average two-year fixed-term rate and the variable rate by the time of expiry. As the pandemic induced low mortgage agreements to come to an end, homeowners will begin feeling the pinch of servicing loans at inflated rates.
Eliza Owen explains “Not only will the change in rates be stark for expiring fixed terms this year because of more rate rises, but average loan sizes also grew notably from April 2021 during the housing boom.”
Hope as variable rate holders show signs of coping
According to the RBA close to 70 per cent of current outstanding mortgage debt was on a variable rather than a fixed rate in the February Statement of Monetary Policy.
This means that rate hikes have already been felt by the majority of outstanding mortgage debt. Despite this mortgage, households are displaying resilience.
As shown in the figure below, borrowers were still dedicating 15.7 per cent of housing payments to offset and redraw accounts in December. While this figure is below the decade average of 20.1 per cent it is still within an acceptable scope.
“The RBA Financial Stability Review from October last year noted that the current cohort of fixed-rate borrowers have a similar income to variable rate holders, so they should be able to save in a comparable way,” Ms Owen explained.
“An ongoing risk however, that even variable-rate holders have not experienced the full extent of rate rises, with the cash rate expected to continue rising in the coming months.”
The end may be in site
The vast majority of new housing finance is currently being taken out on variable home loan terms. Simultaneously, most fixed-term agreements expire this year. This means that the majority of Australia’s outstanding mortgage debt will fluctuate with the impact of rising interest rates by the end of 2023.
Ms Owen said, “On one hand, this increases the risk of reduced serviceability as interest rates rise. On the other hand, borrowers may be better positioned to seek a lower interest rate as the cash rate passes a peak, which some believe could be as soon as late 2023.”
The CBA highlighted in a recent economic note that the RBA be compelled to start easing off on the rate hikes and rather reduce rates by the fourth quarter this year to avoid a recession.