A Citi banking analyst has warned the major shift to fixed-rate mortgages after the pandemic may create an “Achilles heel” for the Reserve Bank, with average mortgage repayments predicted to lift by 25% to 35% as special home loan deals reset.
Bank analysts have suggested the central bank will only increase rates modestly in response to high household indebtedness, to ensure borrowers don’t get mortgage shock when fixed-rate mortgage deals offered to assist with COVID-19 recovery roll off next year.
Citi’s Brendan Sproules said RBA could have a 1.25% cash rate in 18 months, increasing the average major bank variable rate to nearly 3.75%, up from 2.6% at present, which “creates a conundrum about the speed and effectiveness of monetary policy,” The Australian Financial Review reported.
Fixed rates protect borrowers from higher repayments as they blunt the initial effect of rates rises, but when fixed-rate loans expiring in the second half of the next year roll over, the annual interest repayment of around $27,600 on an average $620,000 mortgage at a 2% rate would become a hefty $34,600, assuming a variable rate of 3.75%, the report said.
There had been a dramatic structural shift towards fixed-rate loans within the Australian mortgage market when the Term Funding Facility was launched by RBA in 2020 to provide low-cost three-year funding to banks. The initiative encouraged banks to take their allocation and offer duration-matched loans.
Prior to the pandemic, some 60% of new mortgages were on variable rates while 40% were fixed. This flipped during last year, with some 80% of new loans being on fixed rates. A relatively large amount of banks’ overall mortgage books have been originated in the past 18 months, as refinancing surged, AFR reported.
“Here lies the conundrum for Dr Lowe,” Sproules wrote to Citi clients over the weekend. “If the RBA raise rates too fast, 40% of the book might be set for a rude shock when their fixed term (typically two years) expires.”
RBA is expected to start lifting rates in the third quarter of this calendar year, with a total of four rate rises expected by the end of December. There is considerable debate, though, about the size of the bank’s adjustments, AFR said.
Sproules told the publication that the level of mortgage debt in Australia “is providing an additional curve ball for the RBA this time around” and that “this is a very significant change in composition in the context of a $2 trillion mortgage lending market and likely to have serious implications for the RBA’s rising cash rate trajectory over the next 12 to 18 months.”
