Mortgage Cliff – Fact or Fiction? – August Market Update
August 2, 2023 / Written by Rich Harvey
Written by: Rich Harvey, CEO & Founder
The volume of fixed rate mortgages expiring will peak in the second half of 2023. Households with highly leveraged mortgages will face a critical financial juncture - The key question is… what proportion of households will be able to cope with these higher rates? And how will this impact the property market?
This month I take a deep dive into mortgage world to discuss how you can best prepare to deal with higher interest rates, and how you could take advantage of these dynamic economic conditions.
Mortgage Cliff – Fact or Fiction?
The volume of fixed rate mortgages expiring is due to peak between June and October of 2023. Many households with highly leveraged mortgages will be facing a critical financial juncture as they come off cheap fixed rates of around 2% and are hit with a new mortgage rate of circa 6%. The key question is… what proportion of households will be able to cope with these higher rates ….and for how long?
With cost of living pressures rising coupled with mortgage repayments jumping so quickly, there will no doubt be many households struggling to work out how to make ends meet. How will this play out in the property market? How can you best prepare to deal with higher interest rates for holding your own mortgage(s), and secondly how could you take advantage of these dynamic economic conditions?
What is the “Mortgage Cliff”
Firstly, let's unpack exactly what is this so called “Mortgage Cliff”? Many borrowers took out very cheap fixed rate mortgages during the Covid pandemic and will now need to find many thousands of dollars extra to cover their repayments per month - this is commonly referred to as the mortgage cliff. Another colloquial term that is doing the rounds is “mortgage prison” a situation where a borrower is unable to refinance to another lender offering a cheaper rate, because they are unable to prove serviceability with the new lender’s criteria or the value of their property has dropped temporarily. So essentially this borrower is stuck on their existing higher interest rate.
What volume of fixed rate mortgages are expiring in the coming year?
The Reserve Bank of Australia (RBA) has estimated that over 880,000 "fixed rate" mortgages will expire this year and another 450,000 in 2024. See chart below from the Australian Banking Association, which demonstrates that the volume of fixed rate mortgages expiring in the June quarter at 78,300, will triple in volume to over 222,800 in the June quarter. Then in the following two quarters we will see significantly large volumes of fixed rate mortgages also expiring - 208,000 in September and 184,000 in December.
In 2024, a further 350,000 fixed rate loans are also due to expire.
Where will the mortgage pain be the most acute?
It is hard to say with any degree of accuracy where the mortgage pains will be most severely felt - but we do know that households with highly leveraged mortgages will be the most at risk of experiencing severe mortgage stress. And those buyers that purchased property within the last 12 months when the property market corrected and had a loan to value ratio over 90% could potentially be in negative equity situation.
How much more will the average borrower pay?
Let's look at three scenarios where the increase in mortgage repayments jumps from the average variable rate that was fixed at three years for 2.5% and will now be paying 6% (after all the recent interest rate rises). Depending on whether the Reserve Bank decides to increase rates another one or two times, the total increase in interest rates will be 3 to 4% more for the average borrower.
- For households with a $500,000 loan, repayments will increase by $996 per month.
- For households with a $750,000 loan, repayments will increase by $1717 per month.
- For households with a $1,000,000 loan, repayments will increase by $2289 per month.
The Affordability Factor & Refinancing Challenge
Economic and financial experts are providing conflicting commentary on whether households will be able to afford the rapid escalation in mortgage repayments. If we go back 10 years to 2013, the average mortgage rate was 4.0%, and 15 years ago in 2009 it was 5.04%. Many borrowers have become used to living on a diet of cheap money.
During the pandemic, the RBA estimated that the household sector accumulated $300 billion in excess savings. During the lockdowns we curtailed our spending significantly on travel, retail, building, renovations and a host of other items. So, this savings buffer is likely to provide some level of cushioning against the higher rates. Private survey data suggests that households have additional savings held in bank deposits and other liquid assets, such as managed funds and shar (RBA Bulletin 2023).
On the job front, Australia’s unemployment rate has been an incredibly low 3.5% so that anyone wanting to find work can easily take a range of job options or multiple jobs to secure regular income from reliable employers.
We also need to remember that around 1/3 of the population have a mortgage, 1/3 are renting, 1/3 of people own their home outright without a mortgage, so therefore 2/3 of the population are not directly impacted by interest rate increases on mortgage repayments. The most significant challenge is for the other one third of the population that have to deal with constantly changing interest rates. Borrowers would be wise to consider refinancing their mortgage with the best rates available.
However, as mentioned, some people will be stuck with their current mortgage for potentially a year or two longer than is comfortable and have to suffer painful higher rates because they are unable to refinance, due to strict serviceability ratios by the banks. This situation may soften whereby some banks will assess loan repayments with only a 1% buffer rate above the standard variable rate, compared the 3% buffer required by APRA - but it hasn’t happened at a broad level yet.
What impact will the mortgage cliff have on the property market?
This is the most interesting and difficult question to answer. From my observations, and in discussions with bankers and many mortgage brokers, I am seeing a rising level of mortgage pain and financial discomfort, but I'm not seeing material evidence of forced or pressured selling at this point in time. There is lots of discussion in property investment circles about the higher costs of holding investment property, and the disincentives that some State Governments are putting in place to deter property investors – eg. Victorian Government increasing land tax and contemplating rent caps, and the Queensland Government limiting the number of times rents can be increased to once per calendar year.
There will always be political conjecture around tax policy and property investors but the one thing you can count on is that the longer the conjecture rolls on, the worse the housing supply situation will become. We need ‘mum and dad investors and private individuals to help create housing supply via rental properties. The Government can never provide enough on its own accord.
One of most critical financial indicators that I will be watching like a hawk over the next six months will be the mortgage delinquency rate.
Fitch ratings have assessed the current rate of loans more than 30 days in arrears to be to 0.98%, but this is the lowest level since 2002. Louis Christopher, Managing Director of SQM Research reports that the volume of “distressed sales” currently on the market:
- In July 2023, the number of properties listed as distressed was 5277 which represents just 2.4% of total listings available.
- In July 2022, the number of properties listed as distressed was 6257.
- Compared to Pre-covid levels (i.e., before 2020) the volume of distressed selling was over 12,500.
So, it is clear that distressed selling is currently at less than half the levels of the pre-covid period despite higher interest rates.
One trend that is quite apparent and growing is the increasing proportion of investors selling their investment property.
CoreLogic estimate that 32.7% of new listings coming to the market are owned by property investors which is a 7.7% increase over the past decade which had an average proportion of 25%. This trend shows that property investors are really feeling the pinch and offloading their properties in increasing numbers. This will only worsen the rental crisis as a proportion of these properties will go to owner occupiers incentivised to buy due to low rental supply and increasing fees, rather than staying in the rental pool.
There is greater economic pain coming in the next six to nine months, while a significant proportion of household's transition from fixed rate loans to variable mortgages. Even though inflation is coming down, the real impact of 12 successive interest rate rises will then be seen. I think it is unlikely that we will see a mortgage cliff with tens of thousands of borrowers defaulting and flooding the market with distressed property. So, what can you do to take advantage of dynamic economic conditions?
Here’s my 5 takeaways:
- Rents and prices will continue to rise because of a shortage of housing, and there are selective opportunities for savvy buyers that are in a financial position to make another purchase.
- Take advantage of the pause in RBA cash rate rises and have your home or existing investment property revalued to see if you can leverage equity to buy your first or another investment property. Think outside of your city and even state.
- Look at the greatest demand which is housing. When buying choose stock that appeals to the highest quality tenant you can afford, think of a young professional family. Would they want to live there?
- Don’t believe the headlines, they only refer to one sub-market at a time. This is not the big picture and robs you of opportunities in other sub-markets, of which there are hundreds.
- Think of your property portfolio as a journey of discovery to find the right combination of yield and growth that suits your serviceability. The lenders are hungry for transactions and at the right LVR you can get ahead.