Will you fall off the fixed rate ‘cliff’? Here’s 5 things to know

In October, the Reserve Bank of Australia’s (RBA) October Financial Stability Review found approximately 35 per cent of outstanding housing credit was on fixed terms, with two-thirds of this figure set to expire in 2023, hence the “cliff” assessment.

Over the course of 2023, just under one-quarter (23 per cent) of all outstanding mortgage debt will be re-priced at an increased rate, opening borrowers to the average re-financed interest rates of 5.7 per cent for owner-occupiers and 6 per cent for investors.

Ahead of the approaching fixed rate “cliff”, CoreLogic research director, Eliza Owen, outlined five things Australians should know about the looming expiries.

1. The sting will be felt greatest from April 2023

With average loan sizes growing notably in April 2021, when the fixed variable rate sat at 1.98 per cent, and the looming shift to variable rates, currently 5.48 per cent on average, Ms Owen explained serviceability issues are likely to arise.

“Interest rates have risen beyond three percentage points for many borrowers, which is the minimum serviceability buffer recommended by APRA in assessing whether someone can repay their debt,” she said. 

In her estimation, stretched serviceability could potentially be compounded by rising unemployment rates and slashed household budgets due to increased inflation. 

“A rise in distressed sales could also put added downward pressure on property values,” she added. “If people are forced to sell their home in a declining market, there is an added risk of being unable to recover mortgage debt from the sale of a home.”

2. Variable borrowing has a lot to teach us

The RBA’s February Statement of Monetary Policy revealed just under 70 per cent of outstanding mortgages were on variable rates.

Between April 2022 and the final month of the year, average outstanding variable mortgage rates lifted 263 basis points, leading to the average-sized, 30-year loan secured last April experiencing $935 monthly repayment increases.

“In other words, the majority of outstanding mortgage debt has already been subject to steep rate rises,” Ms Owen explained.

Despite this, “housing market measures show resilience in mortgage households.”

“The new volume of [newly] advertised properties hitting the market for sale nationally remains contained, trending 14.8 per cent below the previous five-year average,” she added. 

Nationally, borrowers are dedicating 15.7 per cent of housing payments to offset and redraw accounts, although these rates are declining and remain below the pre-COVID average of 20.1 per cent.

Ms Owen outlined a remaining ongoing risk that “variable-rate holders have not experienced the full extent of rate rises, with the cash rate expected to continue rising in the coming months.”

3. Variable rates are rising, but they can also come back down

A large majority of new housing finance is being taken out on variable home loan terms, with just 4.9 per cent of lending occurring on fixed terms last December. With the imminent expiration of most fixed-term lending, most of Australia’s outstanding housing debt will be exposed to interest rate fluctuations by year’s end.

While this increases the risk of serviceability as interest rates increase, it also places borrowers in a better position to seek lower interest rates as the cash rate moves beyond its peak, which could occur towards the backend of 2023. 

As such, while increasing variable rates could birth tough short-term conditions, steep interest repayment hikes will not exist for the loan’s lifespan. 

Additionally, Ms Owen said external refinancing hovering at record highs means “banks will also be more incentivised to reduce their mortgage rate offerings to stay competitive.”

4. Equity remains high in most markets

Rising interests could unfortunately see many households fall into arrears and subsequently force them to sell their homes. However, the recent housing boom’s large value gains mean a small portion of borrowers may fail to pay off their debt with the sale of their homes.

“Large deposits also help to strengthen the equity position of mortgage holders,” Ms Owen said.

“RBA assistant governor, Brad Jones, recently noted that around 0.5 per cent of home loans were in negative equity amid current price falls. If home values were to fall a further 10 per cent, the RBA estimates the rate of loans in negative equity would only rise to 1 per cent.”

5. It will take a while to see an impact

“Are we seeing signs of distress in the housing market from a data perspective?” Ms Owen asked. “No, and it will take a long time to show.”

“Official data on ‘non-performing’ loans is produced by the banking regulator APRA on a quarterly basis. The latest publicly available data is [from] September 2022, and non-performing loans themselves are generally considered repayments that have not been made for 90 days or more.”

According to the data from September, just 1 per cent of home loans were at least 30 days beyond their due date. However, this reporting period covers around two-thirds of interest rate increases to date. 

She outlined, “Understanding the impact of rising rates on some households is difficult because different income cohorts and support networks will vary in their response to higher interest costs.”

Some may be able to move in with their parents and rent their homes to cover mortgage repayments, while higher-income earners can generally utilise a higher portion of their income on housing. 

Moreover, she revealed that “institutions will also be working proactively to avoid mass loan defaults in the housing market.”

“Banks may put temporary forbearance measures in place, as with ‘mortgage repayment holidays’ at the onset of the pandemic. For example, distressed borrowers may have the option to extend their loan term, thereby reducing their monthly repayments, or temporarily revert to interest-only repayments.”

“There’s no escaping that Australians with fixed rate loans are about to see a painful adjustment,” according to Ms Owen, adding that “this is partly the intention of rising rates, as households have to curb spending in response to higher interest costs.” 

She concluded that “the true test of the market will be over the next ten months.”