Home loans Fixed-rate borrowers have been insulated from 10 straight RBA interest rate increases. But with credit worth $350 billion close to expiring, the impact could be profound, writes Michael Read.

Up to 880,000 Australian households will need to find hundreds, or even thousands, of dollars more each month when their fixed-rate periods expire this year and the rock-bottom interest rates they’ve enjoyed since the start of the pandemic become a thing of the past.

Until now, these borrowers had been insulated against 10 back-to-back rate rises from the Reserve Bank of Australia that sent variable mortgage rates rocketing.

Households servicing a $550,000 mortgage – the average size of a loan issued between 2020 and 2022 – will face an $891 increase in monthly repayments, and highly indebted households are on the hook for an even larger increase. Someone with a $1 million mortgage would have to fork out an extra $1620 each month.

The ‘‘fixed rate mortgage cliff’’, as it has come to be known, is one of the big challenges for the Australian economy this year, and how these households cope will be critical to whether the country can avoid a sharp downturn.

At the height of the pandemic, interest rates fell to record lows as the RBA tried to prop up the economy amid forecasts of a once-in-a-generation recession.

As part of its policy response, it provided banks access to cheap three-year fixed rate credit, which they then offered borrowers in the form of ultra-cheap, fixed-rate home loans.

The low rates led to an explosion of fixed rate borrowing and refinancing, and many households locked in their rates for two to three years.

Some borrowers entering the property market also took comfort from assurances by RBA governor Philip Lowe that interest rates were unlikely to increase until 2024. The governor has since apologised for the guidance.

At their cheapest point in May 2021, the average new fixed rate loan for a term of three years or less was 1.95 per cent, compared with a new variable rate loan of 2.8 per cent, RBA data shows.

As a result, borrowers took a gamble that interest rates were unlikely to fall further by locking in the lower rate, and by mid-2021 about 45 per cent of new loans being written were fixed, compared with just 5 per cent today.

Over the course of 2020 and 2021, Australian banks lent $394 billion to borrowers in fixed mortgage commitments. Fast-forward to this year, and 880,000 fixed loans written at rock-bottom interest rates are set to switch to much higher variable rates.

According to the RBA, about $350 billion – or half of all fixed rate credit – mortgages will expire this year. This is what is sometimes referred to as the ‘‘mortgage cliff’’.

The remaining 38 per cent of fixed rate credit, which includes about 450,000 loan facilities, will expire next year and beyond.

The pain will be felt most acutely between now and September, when one-third of fixed-term credit will expire, and affected households will be forced to absorb the 350-basis point increase in the cash rate over the past year.

Just how much extra they will need to fork out will depend on what their fixed rate was and whether they roll on to a competitive variable rate.

But regardless of the scenario, they are looking at a 3 percentage point to 4 percentage point increase in their home loan rate, and borrowers who took out mortgages larger than $615,000 will cop a monthly repayment increase of more than $1000.

A household with a $750,000 loan will have to find an extra $1215 per month – or $280 per week – when their loan switches to a variable rate.

This assumes they had locked in a 2.48 per cent interest rate for three years, which is the average, outstanding fixed rate, and refinance to a competitive 5.58 per cent variable rate upon maturity.

Borrowers who took on a $1 million mortgage – not uncommon for new borrowers in Sydney or Melbourne – will cop a $1620 increase in their monthly repayments, or $374 per week, based on these assumptions.

Homeowners servicing a $500,000 mortgage will see their repayments increase by $810 per month, or $187 per week.

Overall, the RBA estimates that 90 per cent of the fixed rate loans rolling off this year or next will have to wear mortgage repayment increases of at least 30 per cent.

After the switch happens, about 25 per cent of fixed rate borrowers will spend more than 30 per cent of their income on their mortgage, the central bank says.

Economists are divided whether the looming, fixed-rate mortgage cliff will mark the start of a sharp economic slowdown or represent a blip on the radar.

Because of the magnitude of the shock, the RBA said in its October Financial Stability Review that it expected an increase in home loan arrears in the period ahead as some borrowers struggled to meet higher repayments.

Westpac CEO Peter King warned in February that almost half of the bank’s $471 billion in outstanding home loans were likely to breach their original serviceability assessments, which tested customers’ capacity to deal with a 3 percentage point rate rise.

The roll-off comes as households are already under pressure. Consumer prices have been increasing at their fastest pace since the early 1990s (although there are signs that these pressures have now peaked) and real wages are at their lowest level in a decade.

The RBA estimates that two in five borrowers with small mortgage buffers (ie less than three months of payments) have fixed rates or are investors with loans in place before 2021.

But a range of factors suggests that households are well placed to manage the roll-off.

The RBA says it is possible fixed rate borrowers kept liquid savings elsewhere, meaning they are less vulnerable than they appear.

The household sector has also accumulated $300 billion in excess savings since the onset of the pandemic, which should at least partly cushion the blow, though these savings mainly sit with wealthy, older people.

Borrowers are also more likely to be in work than at any time in recent history, thanks to Australia’s stellar labour market and near-50 year low jobless rate of 3.5 per cent. Fixed rate borrowers have also had more time than variable rate borrowers to restructure their household budget in anticipation of higher repayments, and also time to build up a savings buffer. However, borrowers with split loans would have already experienced higher repayments on the variable portion of their mortgages.

For their part, the banks say they are ready to help customers struggling to meet repayments.

Westpac’s chief executive said there were tools that banks could use to nurse customers through hardship, including restructuring repayments, and putting borrowers on to interest-only loans.

Banks are also experimenting with extended loan terms that make it easier for customers to repay loans as interest rates climb further, as well as to borrow more upfront.

National Australia Bank’s subsidiary, Ubank, has said it would extend a 35-year mortgage previously offered only to new buyers to those looking to refinance. This would reduce monthly repayments, but end up costing customers much more over the life of the loan.

The federal government’s MoneySmart service says borrowers experiencing hardship should contact their bank as early as possible. Banks must respond to a hardship request within 21 days, and MoneySmart says borrowers should consider selling their home if their circumstances are unlikely to improve.AFR