fixed borrowers to get big shock

Martin Place further revealed that if its cash rate were to increase by 3.5 percentage points overall, “nearly 60 percent of borrowers with fixed-rate loans would face an increase in their minimum payment of at least 40 percent when they expire” .

This is an interest rate shock that was never meant to happen. Before October 2021, banks are only required by the Australian Prudential Regulation Authority to apply a mortgage repayment test that involves using an interest rate of only 2.5 percentage points than the actual product rate. The RBA has already raised its target cash rate by more than this (ie, 2.85 percentage points). The market is pricing in a total RBA interest rate hike of up to 3.75 percentage points.

In October 2021, APRA cautiously preempted the RBA, and raised the minimum repayment test buffer for banks to 3 percentage points. (Most non-bank lenders still use a miserly 2.5 percent buffer point.) This, however, will prove insufficient to cope with the circa 350-400 basis point interest rate of interest that the RBA will charge borrowers.

Cheap loans

In other words, there are many borrowers who took out ultra-cheap home loans in 2020 and 2021 on the assumption that the RBA will not raise rates until after 2024 who will now face mortgage payments of 40 percent which is above the maximum of their lender. thought they should serve during their lifetime (ie, through APRA’s stress test).

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Most fixed-rate loans taken out in 2020 and 2021 hit mortgage rates between 1.75 and 2.25 percent. As more than one in five Aussie home loans will have their fixed rates switched to variable rates by the end of 2023, interest rates paid by borrowers will more than double by 5-6 percent.

In contrast to most other countries where the majority of loans are long-term fixed-rate products, the pass-through of monetary policy in Australia has directly hit almost every short-term borrower. This is also why RBA rate changes have a bigger and more immediate impact on our housing market compared to overseas peers.

A key question weighing on the RBA is how much this record increase in the cost of capital will do for consumers’ free cash flow (or their disposable income). This is important for the perspective given that consumer spending accounts for about 50 percent of overall economic growth.

Using RBA data on residential mortgage-backed securities, it found that more than 52 per cent of all borrowers would see their “spare cash” reduced by between 20 per cent and more than 100 per cent, if the target amount of money will rise to 3.6. percent.

Spare cash is defined by the RBA as the income the borrower has left after paying off the loan and “essential living expenses”.

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A staggering 15 per cent of all borrowers will be negative on their spare cash in the RBA’s base case. That means they are at a serious risk of defaulting on their loan payments.

A total of 23 percent of all borrowers – or more than one in five – will see their spare cash drop by between 60 percent and more than 100 percent.

Almost one-third of borrowers will have their free money reduced by between 40 percent and more than 100 percent.

It predicts a big drop in household spending if the RBA takes the 3.6 percent cash rate next year. Note that this is actually slightly below the current market price, which expects a higher 3.85 percent terminal cash rate in mid-2023.

Slower rate increases

The huge decline in Aussie households’ cash reserves is almost certainly one reason why the RBA is comfortably slowing the pace of its interest rate hikes and signaling it will soon stop to catch up on the cumulative impact of this. changes.

Due to several months of lags between the RBA raising the target amount of money and the lenders actually passing these increases on to borrowers, the transmission of actual consumer spending, demand and pressures Price changes take time. And it will take several months for these changes in household behavior to show up in official economic data, which are reported on a lagged monthly or quarterly basis.

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Households clearly sense that their cash flows are about to collapse. This is confirmed by consumer confidence data, which is worse than levels recorded during the GFC. And this is also reflected in real time in the daily home price indices reported by CoreLogic.

National home prices fell at a record 14 percent annual rate based on the last three months of data from CoreLogic, with a total drawdown of 7.4 percent since the May 2022 high mark of water in the five capital city indexes.

The epicenter of what may be the biggest housing crash in modern Aussie history has shifted from Sydney to Brisbane, where prices have fallen at an incredible 20.3 per cent annual rate (Brisbane values ​​have os of 7.7 percent peak-to-trough so far) .

Sydney home values ​​fell the furthest, falling a whopping 11.1 per cent since their peak in absolute terms. Unfortunately for home owners, Sydney home values ​​continue to decline at a 17 per cent annual rate based on the past three months of price movements.

This is a second channel through which monetary policy affects behavior – through a large negative effect on wealth.

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