Mortgage costs to jump as interest rates rise, warns BCA ahead of Reserve Bank meeting

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Australians could soon pay more than $ 26 billion a year in additional mortgage payments as interest rates begin to ‘normalize’, but the Commonwealth Bank argues that there are several reasons why most households will be able to do very well.

The Reserve Bank’s next rate decision, which will be announced today at 2:30 p.m. AEST, will be widely watched, but not because anyone expects it to change the official treasury rate, to an all-time high. 0.1%.

This does not mean, however, that Reserve shares will leave interest rates unchanged.

It is widely expected to change its government bond buying program, which has been a major factor pushing mortgage rates – especially fixed rates – to record highs.

Even before the announcement, many longer-term fixed mortgage rates (three years and over) rose, with NAB the latest major bank to cut its two, three and four year home loans by up to 0.1 point percentage. higher.

While it may not be reported, even in a rare press conference by Reserve Bank Governor Philip Lowe after the meeting, a growing number of analysts expect interest rates to rise. before the previous RBA timeline, not before 2024.

Australians could pay $ 26 billion more in interest by 2023

Leading among them is the Commonwealth Bank, with Australian chief economic officer Gareth Aird recently announcing the first rate hike for November 2022, with several more leaving the spot rate at 1.25% before the end of 2023. .

Her colleague Belinda Allen went on to analyze what this might mean for Australian households now accustomed to falling interest rates over the past decade.

The most recent figures from the World Bank for International Settlements from late last year show Australian households spent 13.6% of their income on home loans.

(Remember, only about a third of households have home loans, and many of them have paid off much of their debt.)

That’s down from a peak of 17.6 percent in mid-2008, just before the global financial crisis, when the RBA’s cash rate was 7.25 percent.

With the RBA’s cash rate now at just 0.1%, you would have thought home loan payments would have fallen further, but in the meantime these low and falling rates have encouraged people to take on debt. much larger for much more expensive houses leaving much more capital to repay.

Excluding principal repayments, interest on mortgage debt currently represents only 3.1% of household income. The peak in 2008 was 8.5 percent and the recent average is around 5 percent.

Households pay the smallest percentage of their income in interest charges since the early 2000s.
Households pay the smallest percentage of their income in interest charges since the early 2000s.(

Provided: CBA

)

The CBA notes that due to the increase in debt, a cash rate of 1.25% will leave mortgage rates at levels that will again absorb about 5% of household income in interest payments.

In other words, we’ll go from one of the lowest mortgage payments we’ve had in the past two decades to something around average.

According to national accounts data on which the CBA’s analysis is partly based, Australians spent around $ 10.7 billion in the March quarter on real estate interest.

The kind of rate hike the ABC is planning would result in an increase in the interest bill of around $ 26 billion a year – a sum of money Australian households won’t spend in stores, on vacations or in outputs.

Australians may face “modest hike” in interest rates

However, Allen points out that there are several offsetting factors that should soften the shock of rising interest rates for many households.

For starters, even if the ABC’s prediction of a rate hike before the end of next year turns out to be correct, many borrowers won’t see their first rate hike until one, two, or even three years later. .

That’s because fixed rates have become much more popular since the onset of the COVID-9 pandemic, when Reserve Bank stocks took the cheapest ones below 2%.

Fixed rate mortgages were only 20 percent of outstanding home loans at the start of last year, now they are 30 percent.

The CBA’s own experience is that over 50 percent of new homeowner loans, and just under half for investors, in recent months have been fixed.

ABC internal data shows that about half of new loans are stuck at fixed interest rates.
ABC internal data shows that about half of new loans are stuck at fixed interest rates.(

Provided: CBA

)

Obviously, once this fixed period is over, borrowers will experience a rate shock, but they will at least have time to prepare before they feel the impact of the rate hike.

Then there’s the savings buffer that many households built up during COVID when many incomes were supplemented by additional government support while options for spending the extra money were limited by border closures and lockdowns. periodicals.

Official data from the banking regulator shows Australians collectively accumulated $ 205 billion in mortgage clearing accounts at the end of March, up from $ 171 billion at the end of 2019.

Chart showing a sharp increase in clearing account balances since 2019.
According to the ABC, APRA data shows that clearing account balances now represent 10.8% of outstanding home loans.

This equates to almost 11% of what we owe on our home loans, and it saves us about $ 13 billion a year in interest that would otherwise be owed.

Besides the offset savings, Australians are also generally ahead of their mortgage payments, with around $ 271 billion in prepayments and untapped credit available for further drawdown.

Finally, Allen points out that stronger wage growth of at least 3 percent is practically a prerequisite for rising interest rates.

We will therefore have a higher interest bill, but also higher income to meet it.

“All three factors suggest that a modest hike in interest rates will not have a significant impact on consumer spending,” Allen concluded.

This is the good news. The bad news for the Reserve Bank is that the CBA considers a 1.25 percent cash rate “neutral”, which is the new standard.

This is a level lower than what was previously considered emergency settings at 1.5% and still leaves little room for maneuver the next time something unexpected derails the Australian economy.


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