Fixed interest home loan borrowers head for a cliff

An artificial setting in the banking system allowed a huge number of borrowers to fix loans at ultra-low rates. Should it have been allowed to happen?

Half a million borrowers could face a doubling or more of their home loan rates, an analyst says. Picture: AFP

Now that we know from the RBA that rates are going higher, the banks are suddenly facing a most unusual problem: homeowners who “fixed” at exceptionally low rates are heading for an abrupt end to their honeymoon in the months ahead.

It’s what they call the “cliff”, where home borrowers find their fixed term is over and suddenly their mortgage payments rise sharply. The question now is whether it should ever have been allowed to occur.

It’s an accident waiting to happen. At the peak of the fixing trend, almost half of all new mortgages locked into longer-term deals, typically for three years.

But keep in mind this group were offered not just low rates – in the depth of the Covid downturn they were offered artificially suppressed low rates.

Big banks could price their fixed products off the suppressed bond rates held down by the RBA. The money was so cheap the banks were offering fixed-term mortgages very close to 2 per cent, which were cheaper than variable loans – that’s against the laws of economics.

Worse still, the borrowers heard repeatedly from the RBA that they should not expect rates to move until 2024. This fanciful notion was echoed by the banks themselves. Privately, of course, economists knew it was wishful thinking on behalf of the RBA trying to stimulate the wider economy – the exercise finished long before the central bank hoisted the white flag last week with the first official rate rise in 11 years.

You have to wonder how many borrowers overextended themselves and took out bigger loans than they might have to buy houses that are now dropping in price.

“The rates these people are going to face will rocket,” says Steve Mickenbecker at research group Canstar.

According to Mickenbecker, the collection of borrowers that is smack in the middle of this bubble going through the banking system were those who signed on between April 2020 and November last year: on his estimates, that is at least 500,000 mortgages.

“Half a million borrowers could be facing a doubling and more of their home loan interest rate overnight, as they reach the end of their fixed-rate period,” he says.

A doubling of home loan repayments is a serious shock to a household budget. It also has reper­cussions across the economy, especially for retail – the most vulnerable sector on the sharemarket after this week’s 5 per cent swoon in consumer confidence.

You have to ask why on earth the RBA allowed this to happen. Sure, household mortgage outcomes are not part of its mandate, but certainly the amount and volume of money it pumped into the banking system in the past two years has to be questioned.

During that time, the RBA ­offered the banks about $188bn at 0.1 per cent to keep the economy afloat. This scheme – the Term Funding Facility – facilitated an uneconomic offer in fixed-term home loans across the market.

Fixed rates attracted only 15 per cent of home loan borrowers before the crisis. By the time the RBA was pouring money into the system the portion swelled to a maximum of 46 per cent in August 2021.

Today we have reverted to at least a normal shape in the market where variables are again higher than fixed rates: variable rates are about 3.35 per cent (with last week’s rate added for principal and interest), while three-year fixed rates are closer to 4.5 per cent.

But will this cohort of 500,000-plus borrowers be allowed to drift into trouble? Mickenbecker at Canstar says the issue will emerge in an entirely predictably fashion three years after the fixed rate boom took off (in June 2020), which works out at midyear next year. It will reach at peak in August 2024.

Most lenders and borrowers have never seen anything like this. You would have to go a long way back to when mortgage rates went wild in the early 1990s. At that time, borrowers were fixing at 12 per cent and being relieved by their decision when variable rates hit 18 per cent.

But in many ways this time around is worse: housing is much more expensive, the $1m mortgage is now common and fixed-rate borrowers were a minority.

Some banks, such as NAB, are already preparing for the inevitable onslaught of querulous home loan borrowers. The bank is contacting fixed-rate customer 45 days before their term ends offering them alternatives to the industry standard method of allowing fixed loans to default into whatever the standard variable rate may be at the time.

Will it be as bad as it looks? ­Official rates are now 0.35 per cent and the RBA has indicated they could go to 2.5 per cent next year – that would give us mortgage rates testing 6 per cent.

But CBA boss Matt Comyn said this week he thinks official rates will not get to 2.5 per cent and instead they will top out at about 1.6 per cent mid-next year.

Nobody knows, of course, which is why the bank is keeping its options open: this week CBA launched a term deposit product with a rate of 2.25 per cent. Over what time period you ask? Well it’s an 18-month term, so either Comyn is wrong or that term ­deposit is quite a deal.