OH NO! They’re now talking about another cliff – the fixed mortgage rate cliff

Remember all those scary headlines about the "cliffs" we were going to fall off during the Covid pandemic?

There was a fiscal cliff, then an interest rate cliff, and there was an unemployment cliff where unemployment would jump to double digits.

By the way... no one fell off those cliffs, did they?

Well...now there's talk about a fixed interest rate cliff

You see.. while millions of Australians who are locked into ultra-low fixed rates will not feel the heat of recent RBA hikes, the suggestion is that the rate they pay for their mortgage could more than double when their fixed terms expire.

Proportion of big four bank residential mortgages currently fixed:

RateCity.com.au analysis of the big four bank half-year results and APRA loan book data show approximately 38 per cent of home loans are currently fixed, in dollar terms, with the peak of people coming off their fixed rates around mid-to-late 2023.

Source: Big four banks’ half-year results; CBA results ending December 2021, Westpac, NAB, ANZ results ending March 22. CBA proportion includes BankWest. The proportion without BankWest is 39%.

When are most people coming off their fixed rates?

• CBA: the peak of borrowers coming off fixed rates will be between July and Dec 2023 ($53 billion worth of loans expire in this 6-month period).
• Westpac: expiring fixed loans will peak between July and Dec 2023 ($48 billion).
• NAB: expiring fixed loans will peak between April and Sept 2023 ($29.7 billion).
• ANZ: not supplied.

People coming off fixed rates could see repayment rises of up to 45%

ABS data shows fixing peaked in popularity in July last year when 46 per cent of new loans were fixed.

If someone with a $500,000 loan fixed in July 2021 on the average big four bank 2-year rate of 1.94 per cent, they would currently be paying $2,105 in monthly repayments.

This is based on someone on a package loan paying principal and interest with 25 years remaining.

When their fixed rate ends in July 2023, they would be looking at an average revert rate of 5.68 per cent, if forecasts for the cash rate are realised.

Their monthly repayments would rise to $3,042 – an increase of $937 per month.

Even if they managed to renegotiate their loan to the big four banks’ average lowest variable rate, they would still be paying 4.42 per cent – more than double what they are currently on, with an increase in monthly repayments of $600.

The fixed-rate cliff: increase in repayments for someone coming off a 2-year rate next July

Based on an owner-occupier with a $500K debt, 25 years remaining:

Source: RateCity.com.au.
Notes: Based on an owner-occupier paying P&I with a $500,000, 25-year loan in July 2021 at the average big four 2-yr rates of 1.94% then moving to the average Big4 bank revert rate or lowest rate. 2023 rates are based on forecasted cash rate hikes from Westpac and assume they are passed on in full.

RateCity.com.au research director, Sally Tindall, said:

“Every time the RBA hikes the cash rate, people on a fixed rate won’t pay an extra cent – for now.

However, borrowers’ fixed rate immunity will only last for so long.

When the merry-go-round stops, it’s going to be a shock for many because their new rate will be significantly higher.

An owner-occupier who fixed in July last year at a rate under 2 per cent could be looking at a revert rate starting with a ‘5’ this time next year.

Even if they move onto their banks’ lowest variable loan, their rate could more than double.

If you’re on a fixed rate, enjoy the reprieve but don’t become complacent.

You can still take steps now to cushion the blow when D-day comes.

While fixed rates typically come with caps on extra repayments, find out what they are and consider tipping extra into your home loan while you’re paying less interest.

The lower your loan size when you come off your fixed rate, the less of a shock the hikes will be."

What happens when people’s fixed rates wrap up?

At the end of the fixed-rate period, the loan switches over to the bank’s ‘revert’ rate, which is often a relatively high variable rate.

At this point, borrowers can refix or try to renegotiate a lower variable rate.

Borrowers can also move to a different lender, without having to pay break fees, provided they pass their new bank’s serviceability tests.

Sally Tindall explains:

“Your bank should contact you before the fixed period comes to an end to explain your options, but know you’re only being presented with one set of possibilities.

There’s an entire market out there ready to compete for your business.

It’s worth taking a look at the alternatives.

“If you’re on a fixed rate, set a reminder two months out to start considering your next steps.

The last thing you want to do is roll over to an excessively high variable revert rate, particularly if you’ve got a large loan."

Who might struggle when they hit a cliff?

While most people will be able to tackle the fixed-rate cliff head-on, some borrowers may find their options are limited because of changing economic conditions.

A more stringent stress test from APRA introduced late last year means home loan applicants, including refinancers, must show they can afford the monthly repayments at 3 per cent more than current rates.

With mortgage rates expected to be significantly higher next year, this could prove difficult for anyone who recently took out a large loan compared to their income.

Falling property prices also have the capacity to force some borrowers into a ‘mortgage prison’ where they are unable to refinance.

Borrowers who bought recently with a small deposit could find their equity (the amount of the home they own) falls below 20 per cent.

This would make it costly to switch banks as they would have to pay lenders’ mortgage insurance.

In some cases, lenders might decide not to take them on at all due to their equity position.

For example, if someone bought a median-priced house in Sydney at the end of last year with a 20 per cent deposit, fixed for two years, the amount of equity in their home could shrink to just 13 per cent at the end of 2023, if the property price and cash rate forecasts from Westpac’s economics team are realised.

This would leave them with a loan-to-value ratio (LVR) of 87 per cent, making it difficult to refinance.

Someone buying the same house with a 10 per cent deposit under the same circumstances could find they have just 3 per cent equity in their home (LVR of 97 per cent) after two years, while someone with a 5 per cent deposit at purchase might find themselves in negative equity with an LVR of 103 per cent, making it all but impossible to refinance.

Source: RateCity.com.au.

Calculations are based on an owner-occupier paying principal and interest on the average big four bank 2-year fixed rate in Dec 2021 and CoreLogic median house prices as of 31 December 2021.

Assumes cash rate and property prices will change in line with forecasts from Westpac, which predicts Sydney dwellings will drop 3% in 2022, a further 9% in 2023 and a further 2% in 2024.

Sally Tindall said:

“While the vast majority of borrowers coming off a fixed rate should be able to refinance without raising even a single eyebrow, anyone who bought recently and overstretched themselves to do so, should double check their financial position before they refinance.

Families that haven’t had a decent pay rise in the last couple of years could find they no longer meet banks’ stricter serviceability tests, particularly if they bought when rates were low and borrowed as much as they possibly could.

Borrowers who own less than 20 per cent of their property value when their fixed rate ends could find they’re forced into negotiating solely with their current lender, or risk having to pay lenders’ mortgage insurance."

About Brett Warren Brett Warren is National Director of Metropole Properties and uses his two decades of property investment experience to advise clients how to grow, protect and pass on their wealth through strategic property advice.