What is a mortgage cliff? Please explain.
If you’ve caught any news bulletin or picked up the paper in recent months, you’ve undoubtedly seen or heard the term ‘Mortgage Cliff’ being bandied about. It sounds terrifying - the stuff of nightmares. Let’s take a deep dive into what it actually is and whether it’s something to worry about.
A little bit of context…
Currently about one in three Australian home loans have a fixed interest rate (RBA). This spiked dramatically in the last few years while Australians endeavoured to lock in record low interest rates. In the coming financial year, about half of these fixed rate loans will expire converting to a variable rate interest loan.
A fixed rate loan by definition means that you’ve locked in an interest rate (the cost of your loan) for a set period of time. Most Australian banks will offer fixed rates for periods between 1 - 5 years. If interest rates go up or go down during the fixed rate period, your interest rate will stay the same until the fixed rate period ends.
For example, you might have taken out a home loan in June 2021 and chosen a fixed rate of 1.92% p.a. for 2 years. Since then, interest rates have gone up increasing the over all cost of home loans and monthly repayments for anyone with a variable rate home loan. For the fixed rate customers, your rate and repayments have stay the same.
Which brings me to the ‘Mortgage Cliff’…
Since May 2022 to now the Reserve Bank of Australia has announced 9 interest rate hikes bringing the official cash rate to 3.35% and the average variable interest rate home loan to around 6%.
It’s been a tough time for anyone with a variable rate home loan because with every interest rate hike their home loan repayments have increased.
According to Rate City, a borrower with a home loan of $750,000 has seen their repayments increased by $1,362/month. If you think about how much that adds up to over the course of the year, it’s in excess of $16,000 extra in repayments. So, good bye overseas holiday - that money is being redirected to home loan repayments.
As mentioned previously, anyone with a fixed rate hasn’t been experiencing these repayment increases… until now. About half of all fixed rate home loans are set to expire in the next financial year. Meaning that these borrowers are going to experience a huge and sudden jump in their repayments.
Let’s revisit the example of a borrower who fixed a mortgage of $750,000 at the ultra low interest rate of 1.92%. Your repayments have been around $3,148/month. Say we have one or two more rate rises before your rate expires and you roll onto an interest rate like 7.16% then you could see your repayments jump to $5,198/month - almost $2,000 more in a single hit. Ouch.
Now this is set to happen to about 800,000 (RBA) homes in Australia.
The consequence, a lot of people are going to suddenly experience a big dent in their available spending money. Causing a drop in consumer spending and a lot of tricky conversations around the kitchen table.
So what can you do about it?
Well if you’re a person who has a fixed rate mortgage my best advice is to be on the front foot and get organised early!
Reach out to your home lender
Find out what interest rate you will have when your fixed rate expires and what kind of monthly repayment that will be. Start setting aside money as if you’re making that repayment now. Not only will it get you used to paying a higher repayment but it will also build up your cash buffer.Reprioritise your spending where possible
This is an excellent time to look at where your money is going and repriotise any spending that is unnecessary or not giving you value. So look at things like bills that you can switch to a better deal with, any unused subscriptions, can you make more budget friendly choices when it comes to dining out or transport?Talk to a Mortgage Broker
Ideally you want to reach out to a mortgage broker about 3 months before your fixed rate expires. This way you’ve got time to assess your options with the Broker and make a plan of action.Talk to your existing lender
If you can get a great rate and stay with your existing lender then that’s ideal. So use the intel gathered from your chat with the mortgage broker and take it back to your bank. Say ‘hey, here’s the best rate I can get from the market, can you match it?"‘.Refinance to an alternative lender
If you’re existing bank isn’t coming to the table with a great rate then it’s time to switch to an alternative lender. There’s lots of competition for new customers and many lenders are offering incentives like cash backs to win your business.
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