The Mortgage Minefield

Last May, the Reserve Bank shattered the optimistic view held by some that interest rates would stay low forever (or at least a few more years). The bank has raised the official cash rate eight times in eight months, and lenders have been quick to follow with mortgage rate rises of their own.

While some borrowers have already had to come to terms with the new reality, others haven’t needed to because they’ve been sheltered by having fixed-rate home loans. Fixed rate loans can be attractive because they do exactly what they’ve been doing – protecting a borrower from the impact of rising interest rates. But all good things come to an end, and now we’re hurtling towards what’s been called the mortgage cliff.

What that means is a lot of fixed rate loans are all maturing in a very short period of time – in this case, before the end of 2023.

It’s a big problem. How big? About $500 billion in loans will soon move from sheltered low rates, to much higher (and rising) variable rates.

A repayment shock

Monthly repayments on a $600,000 standard variable rate loan were $2,700 a year ago. Now, those payments are $700 higher at $3,500. But it’s been a gradual increase, and borrowers who’ve copped modest regular hikes in their mortgage payments since May are likely already to have adjusted their circumstances. As rates continue to rise, they’re already prepared.

But someone who’s been enjoying a honeymoon fixed rate of below 2 per cent for the last couple of years is going to get dropped straight into the fire. Instead of paying $2,500 each month, they’ll be up for $3,500. And if they opt for another fixed term, the best deal they’ll get from the major banks is monthly payments of $4,250. And that’s based on today’s rates, not market rates over the next few months. Even the Reserve Bank admits that we haven’t seen the end of the current cycle.

Mortgage brokers – the solution or the problem?

Australians have embraced mortgage brokers over the last decade. 70% of home buyers use brokers to source funding, and brokers are an important distribution channel for the major banks. For those smaller banks and non-bank lenders without a branch network, mortgage brokers are vital.

Not everyone is a fan of the industry. The recent Banking Royal Commission was highly critical of its commission-based pay structure, labelling it conflicted remuneration.

An earlier ASIC report found that broker customers had an increased likelihood of falling into arrears, pay down their loans more slowly, and on average pay more interest than customers who dealt directly with the bank.

That won’t be of concern to those needing to cushion the impact of higher mortgage payments this year – the majority will still contact a broker to find a new loan. And those brokers are going to be busy, because around 1.3 million loans are coming off a fixed rate before the end of the year.

While they may have plenty of customers coming through the door, brokers don’t have much in the toolbox to minimise the impact. That’s because the people likely to be most affected by higher interest rates tend to be those with the least ability to negotiate a good deal.

The mechanics of mortgage rates

The lowest rates on offer aren’t available to everyone. To squeeze a great deal from a banker, you’ll need a good income, high job security, and a low loan to valuation ratio. The more you borrow in relation to the value of your home, the higher the interest rate. Typically, borrowings in excess of 80 per cent of the security value will require Lenders Mortgage Insurance, as well as attract a higher rate of interest.

That means highly-geared borrowers will find it difficult (and expensive) to switch mortgage lenders. Many banks are currently offering thousands of dollars in cash incentives to switch. But that may not be enough – the cost of Lenders Mortgage Insurance can run to the tens of thousands.

For a final sting in the tail, house prices are falling rapidly, and that could continue for some time. Those who bought at the top of the market could find their shrinking equity will make it very difficult for them to negotiate a new loan.

This could affect all of us

Some economists say the risks of the mortgage cliff have been overstated. They argue borrowers on fixed rate loans have been paying less than those on variable rates for a couple of years, and will have been squirreling away funds to prepare for a jump in repayments.

That’s undoubtably true for many. There will also be those who’ve borrowed to the hilt, expecting property prices to keep rising and haven’t saved a cent. Not to mention a new generation of property investors who’ve been told to “keep using your home equity to buy more property.” Some borrowers are headed for trouble.

In some cases, people will be forced to sell because they are unable to refinance or meet their repayments. More sellers on the market puts downwards pressure on property values – a downwards spiral if you like, because lower property values means more people will be forced to sell.

Then there’s the collateral damage, like lower bank valuations (and share prices), greater social disruption, and potentially, a worsening of the current rental crisis.

Will any of this actually happen? We’ll find out in around twelve months.

This article contains factual information only and is not intended to be general or personal financial advice, and is for educational purposes only.