The cost of mortgages will rise due to rising interest rates, the Central Bank warns before the meeting of the Reserve Bank

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Soon, Australians may be paying more than $ 26 billion a year in additional mortgage payments as interest rates begin to “normalize,” but Commonwealth Bank says there are several reasons most households will be able to cope well.

The next Reserve Bank rate decision, to be announced today at 2:30 pm ET, will be widely monitored, but not because anyone expects it to change the official cash rate to a record low of 0.1%.

However, this does not mean that the actions of the Reserve Fund will leave interest rates unchanged.

It is expected to make adjustments to its government bond buying program, which was the main factor pushing mortgage rates, especially fixed ones, to record lows.

Even ahead of the announcement, many long-term (three-year or more) fixed mortgage rates rose, with NAB becoming the last major bank to increase its two-, three- and four-year home loans by as much as 0.1 percentage point. above.

While this cannot be noted, even at a rare press conference by Reserve Bank governor Philip Lowe after the meeting, a growing number of analysts expect interest rates to rise earlier than the RBA’s chart was earlier – no earlier than 2024.

Australians may be paying $ 26 billion more in interest by 2023

The largest among them is the Commonwealth Bank, which heads the Australian Department of Economics. Gareth Aird recently announced its first rating hike for November 2022.and a few more to keep the interest rate at 1.25% until the end of 2023.

His colleague Belinda Allen analyzed what this might mean for Australian households, now accustomed to falling interest rates over the past decade.

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

(Remember that only about a third of households have home loans, and many have paid off most of their debt.)

That’s below a peak of 17.6 percent in mid-2008, just before the global financial crisis, when the RBA’s money rate was 7.25 percent.

With the RBA rate now at just 0.1 percent, you might think that home loan payments would fall even further, but in the years that followed, these low and falling rates encouraged people to borrow much more for much more expensive homes. leaving home. much more than the principal.

Except for principal repayments, interest on mortgages currently accounts for only 3.1% of household income. The peak in 2008 was 8.5%, and recently the average is around 5%.

Households have paid the lowest percentage of their income as interest expense since the early 2000s.
Households have paid the lowest percentage of their income as interest expense since the early 2000s.(

Supplied by: CBA

)

The CBA notes that due to rising debt, the 1.25% interest rate will leave mortgage rates at a level that will again absorb about 5% of household income in the form of interest payments.

In other words, we will move from some of the lowest mortgage payments in the past two decades to an average level.

Australians spent about $ 10.7 billion in the March quarter on property interest, according to national accounts data, which is partly based on the Central Bank’s analysis.

This rate hike, which the CBA predicts, will result in an interest rate increase of about $ 26 billion a year – a lot of money that Australian households will not spend in stores, on vacation or outing.

Australians can deal with “moderate hike” in interest rates

However, Ms Allen notes that there are several offsetting factors that should cushion the blow of interest rate hikes for many households.

For starters, even if the CBA’s forecast of a rate hike by the end of next year turns out to be correct, many borrowers will not see their first rate hike a year, two or even three years after that.

This is because flat rates have become much more popular since the start of the COVID-9 pandemic, when the actions of the Reserve Bank made the cheapest rates below 2%.

At the beginning of last year, fixed-rate mortgages were only 20 percent of outstanding home loans, and now they are 30 percent.

The CBA’s own experience shows that over 50% of new loans to tenant owners and slightly less than half to investors have been recorded in recent months.

Internal data from the CBA show that about half of new loans have a fixed interest rate.
Internal data from the CBA show that about half of new loans have a fixed interest rate.(

Supplied by: CBA

)

Obviously, at the end of this fixed period, borrowers will have some interest rate shock, but they will have at least some time to get ready before feeling the impact of the rate hike.

Then there is the savings buffer that many households created during COVID, when many incomes were boosted by additional government support, while spending extra money was limited by border closures and periodic lockdowns.

Official figures from the banking regulator show that at the end of March, Australians had a total of $ 205 billion hidden in their mortgage accounts, up from $ 171 billion at the end of 2019.

Chart showing significant increase in offset account balances since 2019.
According to the CBA, APRA data show that offset account balances are now equal to 10.8% of outstanding home loan debt.

This is the equivalent of nearly 11 percent of our mortgage debt, and saves us about $ 13 billion annually in interest that would otherwise be owed.

Aside from compensatory savings, Australians also tend to outpace mortgage payments, with an estimated $ 271 billion in advance payments and unused loans available for reallocation.

Finally, Ms Allen notes that stronger wage growth of at least 3 percent is in fact a precondition for raising interest rates.

This way we will have a larger interest account, but also larger returns to cover it.

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

This is good news. The bad news for the Reserve Bank is that the CBA considers the 1.25% interest rate “neutral”, that is, the new norm.

This is below the 1.5 percent level that was previously considered emergency, and it still leaves very little wiggle room the next time something unexpected knocks Australia’s economy out of the way.



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