Mortgage costs will rise when interest rates rise, the CBA warns before meeting the Reserve Bank


Australians could soon be paying more than $ 26 billion a year in additional mortgage repayments if interest rates “normalize”, but the Commonwealth Bank argues that there are several reasons most households will do just fine.

The Reserve Bank’s next rate decision, announced today at 2:30 p.m. AEST, is widely watched, but not because anyone expects it to change the official cash rate, which is at a record low of 0.1 percent.

However, this does not mean that the reserve’s measures will keep interest rates unchanged.

It is widely expected to streamline its government bond purchase program, which was a major factor in pushing mortgage rates – especially fixed rates – to record lows.

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

While this may not appear even in a rare post-meeting press conference by the Central Bank Governor Philip Lowe, a growing number of analysts are anticipating rate hikes ahead of the RBA’s previous schedule of not before 2024.

Australians could pay $ 26 billion more in interest by 2023

First up is Commonwealth Bank, whose head of Australia’s economics department Gareth Aird recently tipped the first rate hike for November 2022, and several others that are keeping the cash rate at 1.25 percent through the end of 2023.

His colleague Belinda Allen then analyzed what this could mean for Australian households, which are now used to interest rates falling over the past decade.

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

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

That’s a decrease from a high 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 cash rate now down to 0.1 percent, one might have thought that home loan repayments would have fallen more, but in the intervening years, those low and falling interest rates have encouraged people to buy far larger debts for much more expensive ones Houses to take on are much more principal to be repaid.

Without repayment of the amortization, the interest on mortgage debt is currently only 3.1 percent of household income. The high in 2008 was 8.5 percent, the most recent average around 5 percent.

Households are paying the lowest percentage of their income in interest costs since the early 2000s.
Households are paying the lowest percentage of their income in interest costs since the early 2000s.(

Delivered: CBA


The CBA notes that due to rising debt, a cash interest rate of 1.25 percent will keep mortgage rates at a level that will again devour around 5 percent of household income in interest payments.

In other words, we’re going to move from some of the lowest mortgage repayments we’ve had in the last two decades to roughly an average amount.

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

The kind of rate hikes CBA predicts would cause the interest bill to rise about $ 26 billion a year – a lot of money Australian households won’t be spending in shops, on vacation, or going out.

Australians can handle a “modest rise” in interest rates

However, Ms. Allen points out that there are several opposing factors that should mitigate the blow of rising interest rates for many households.

Even if the CBA’s forecast of a rate hike by the end of next year proves correct, many borrowers won’t see their first rate hike until a year, two, or even three years later.

That’s because fixed rates have become much more popular since the beginning of the COVID-9 pandemic, when the Reserve Bank’s actions took the cheapest below 2 percent.

Fixed-rate mortgages made up just 20 percent of outstanding home loans early last year; today it’s 30 percent.

According to CBA’s own experience, more than 50 percent of new loans in the past few months have been committed to owner-occupiers and almost half to investors.

CBA's internal data shows that around half of new loans are fixed-rate pegged.
CBA’s internal data shows that around half of new loans are fixed-rate pegged.(

Delivered: CBA


Of course, after that fixed time limit, borrowers will experience an interest rate shock, but they will at least have some time to prepare before they feel the effects of rising interest rates.

Then there is the savings buffer that many households built during COVID, when many incomes were topped up with additional government support, while opportunities to spend the extra money were limited by border closings and regular lockdowns.

Official banking regulator data shows that Australians had written off a total of $ 205 billion in mortgage accounts at the end of March, up from $ 171 billion at the end of 2019.

Graph showing a sharp increase in balanced account balances since 2019.
CBA says APRA data shows that balanced account balances now account for 10.8 percent of outstanding home loans.

That’s nearly 11 percent of our home loan debt and saves us about $ 13 billion annually in interest that would otherwise be owed.

Savings balanced aside, Australians are also typically ahead of their mortgage repayments, with an estimated $ 271 billion in prepayments and unused loans available for resumption.

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

So we will have a larger interest bill, but also greater income to cover it with.

“All three factors suggest that a moderate increase in interest rates will not have a material impact on consumer spending,” concluded Ms. Allen.

That is the good news. The bad news for the Reserve Bank is that the CBA regards a cash rate of 1.25 percent as “neutral,” which is the new normal.

This is below what was previously considered emergency hires at 1.5 percent, and there is still little room for maneuver next time something unexpected throws the Australian economy off track.


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