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An estimated 800,000 home loans totalling $350 billion will fall off a ‘mortgage cliff’ this year when the loan switches from a fixed interest rate to a higher variable rate, according to estimates from the Reserve Bank of Australia (RBA).
More than one in five mortgage holders are at risk of experiencing mortgage stress due to ballooning monthly repayments that consume more than a third of their monthly income. A further 15% of households are considered “extremely at risk”, according to Roy Morgan research.
Another worrying term, ‘mortgage prison’, has also emerged to describe a situation whereby the mortgagee cannot refinance their mortgage and ends up trapped with the higher rate. That is to say, the mortgagee is earning the same amount as when they took out the mortgage, but thanks to rate rises, they cannot afford to repay the amount they owe. Recent analysis by KPMG reveals the potential scale of the mortgage cliff. KPMG Australia chief economist Brendan Rynne told The Age that as the average mortgage is now $600,000, a person faces a $16,500 after-tax increase in interest payments alone over 12 months once they roll off their fixed rate.
On February 7, the RBA raised interest rates for the ninth time in less than a year. Since a historic low during the pandemic of 0.1%, the cash rate is now 3.35%. Economists are predicting another one or two rate rises this year, and the RBA Governor Philip Lowe has foreshadowed the need for further hikes.
“Many people expected that rate hikes were coming, although I think the aggressiveness of the hikes has been surprising,” says Adele Andrews, director and finance and mortgage broker at Australian Property Home Loans.
Those most at risk of mortgage stress are first home buyers who bought a home in the last couple of years at a very high LVR [Loan-to-Value Ratio], because the amount outstanding is significant and increasing due to interest rate hikes.
Related: Estimate your Home Loan Repayments with our Mortgage Calculator
What’s the Deal with Fixed Rates?
In Australia, a fixed rate typically lasts between one and five years.
“Over a 30-year mortgage, fixed rates generally turn out to be more expensive than a variable rate,” says CEO at Rate Money, Ryan Gair. “And with a fixed rate, you are hindered in terms of how quickly you can pay off the loan. A break-fee will be incurred if you want to pay it off early.”
Many fixed rate mortgages do not have offset accounts either, which means that extra savings cannot be used to reduce the amount of interest paid on the loan.
“Generally, people take out a two or three-year fixed rate because they’re the cheapest option. It guarantees a certain interest rate so the customer knows exactly what their repayments are going to be each month for that fixed period,” says Gair.
Andrews has worked with a client who had rolled off 2.09% fixed rate and was heading towards an interest rate of 6.37%.
“It was an extraordinary jump. Regardless of how savvy you are with your budget, it will cause difficulties,” she says.
Will People Default on their Mortgage?
Andrews believes that most Australians are in a secure financial position, with savings accrued in offset accounts during the Covid-19 pandemic when discretionary spending was cut due to lockdowns. By 2021, Australian households had amassed an extra $240 billion in savings.
Many people expected that rate hikes were coming, although I think the aggressiveness of the hikes has been surprising
She believes that if households comb through their expenses and make the necessary cutbacks, they are not at risk of defaulting on their mortgage.
“If people cut back on the nice-to-haves such as Uber Eats, I think the vast majority of people will be able to keep a roof over their heads,” she says.
In the United States, the number of borrowers who have three or more payments overdue on their mortgage is up 55% over pre-pandemic levels.
In the US, 30-year fixed term mortgages are common. The arrangement emerged after the Great Depression, when many defaulted on their mortgages and there was a desire to stablise the economy.
Australia has lent on the side of caution when it comes to home loan products, and regulation has typically been stronger than in the United States, says Gair. This means that mortgagees typically end up in less risky situations, with more of a buffer to be able to make repayments when interest rates change.
In the US, the subprime mortgage crisis that began in 2007 arose in part because of ‘NINJA’ loans being offered to people with ‘no income, no job, no assets’ who were unable to make repayments.
What To Do if You're Worried About Your Fixed Rate Ending?
Andrews recommends speaking to a financial expert immediately if you are worried about what will happen when your fixed rate mortgage ends.
This lessens the chances of winding up in ‘mortgage prison,’ whereby the mortgagee cannot refinance and gets stuck with the imposed rate the lender offers when the fixed rate period ends.
“Regardless of when your fixed rate period ends, it is important to do your research on different financing options now—because with each rate increase, borrowing capacities become diminished,” says Andrews.
Each time there is an interest rate hike, lender calculators change—particularly around how household expenditure and expenses are assessed. And as house prices fall, the mortgagee could end up owing more on their house than what it is worth.
Related: How to Refinance Your Home Loan
Frequently Asked Questions (FAQs)
What is a fixed rate?
A fixed-rate loan has an interest rate that remains the same during a set period of the loan and does not move alongside RBA cash rate decisions. The fixed rate typically lasts between one and five years.
“Most customers take out a two- or three-year fixed rate mortgage because they’re generally the cheapest option,” says Ryan Gair, CEO at Rate Money. “It guarantees the interest rate so they know exactly what their repayments are going to be each month for that fixed period.”
Should I fix my rate?
The answer depends on a multitude of factors, such as what your income is in comparison to the total loan amount, and what your risk appetite is.
“If you want certainty rather than getting butterflies in your stomach every time the RBA makes a new announcement, it’s probably not a bad idea,” says director and finance and mortgage broker at Australian Property Home Loans. Adele Andrews. “However, once your rate is fixed and suddenly inflation does drop, your rate will not drop with it.”
If you can comfortably afford repayments at a certain fixed rate for an extended period of time, it may be preferable to ‘set and forget’, says Andrews. If you can stomach a certain degree of volatility, then a variable rate could be worthwhile financially, although there are no guarantees it will be the best option for you.
What is the best fixed interest rate in Australia?
Generally speaking, as of February 2023, the best fixed rate mortgages are between 5 and 7%, whereas competitive variable rates are around 4%.
