Variable mortgages makes Australia a nightmare as interest rates rise

As mortgage rates continue to rise around the globe and are widely tipped to keep increasing into 2023, there are a great many analyses on how different nations may end up faring amid this challenging environment of higher interest rates and high inflation.

While different methodologies produce slightly different results depending on the approach taken, there are two findings that are consistent regardless: Australia is one of the worst placed nations in the world to deal with rising mortgage rates and the United States is arguably the best.

At first glance, there are a lot of similarities between Australia and the US, both being wealthy, developed nations. But when it comes to the approach they each take on mortgages, they are quite literally at opposite ends of the spectrum.

In the US, the overwhelming majority of mortgages are fixed for 30-year terms, locking in the same repayment to the lender, year after year, decade after decade. While shorter duration fixed terms such as 10 or 15 years are also reasonably commonplace, well over 90 per cent of American mortgages are on some form of long-term fixed basis.

In Australia, the opposite has historically been the case, with around 85 to 90 per cent of mortgages being of the variable variety and at the mercy of rising interest rates.

There is a long list of reasons why Australia doesn’t have long-term fixed mortgages like the US, such as a historically far less developed long-term capital market, at times far higher interest rates than those payable on variable and significantly lower bank profits on these types of loans.

For the longest time, this was a benefit of the way mortgages are conducted in Australia, with Australians only seeing rate cut after rate cut from November 2010 all the way through to May 2022.

But as most mortgage holders come to grips with rising variable rates, there is also a challenging new dimension that Australians have never had to come to grips with in such great numbers – fixed rate mortgage holders reverting to much higher variable rates.

Fixed rate cliff

Back in April, the RBA reported that around 40 per cent of mortgages were on some form of fixed term, a major departure from the traditional 85 to 90 per cent of mortgages historically on variable rates.

This shift has helped to insulate more than 1.25 million households from this year’s rising interest rates. Currently almost a million mortgage-holding households will have still not felt the impact of rising rates until the start of 2023, if Westpac’s loan book is representative of mortgage holders more broadly.

By the end of 2023, the proportion of fixed rate mortgage holders not to have experienced rising interest rates will have dropped to a little under a third.

The expiry of this unprecedented large number of fixed rate loans has been referred to as the “fixed rate mortgage cliff” by many, but whether or not it can be defined as a cliff is very much in the eye of the beholder.

If all this sounds familiar, its similar to what occurred in the United States in the run-up to and during the Global Financial Crisis. Borrowers were incentivised by low rates and rapid housing price growth to get into the housing market, only to find that once those low fixed rate loans expired, they were facing significantly larger repayments.

Australian lending standards are better than those seen in the US during that era, but that is not really a high bar to clear. Some borrowers could get a NINJA loan and still buy a home. NINJA was an acronym created for households that had no income, no job and no assets.

Individual households scaling the cliff?

According to data from the RBA, at the absolute low of fixed rates for three-year terms or less in the middle of last year, the average rate on a fixed loan of this term was just 1.95 per cent. Between January and November 2021, the average three-year or less fixed rate loan was written at a rate of 1.95 per cent to 2.1 per cent.

According to statistics from financial platform and comparison site Canstar, as of the end of October the average variable rate mortgage on offer was 5.18 per cent. Since then, interest rates were raised by 0.25 per cent at the RBA’s Cup Day meeting and are widely tipped to rise a further 0.25 per cent at the December meeting.

After that, the interest rate outlook becomes quite a bit more controversial and varied, with analyst and major bank estimates for the peak cash rate ranging from 3.1 per cent to as high as 4.1 per cent.

Australia vs. The World

With the exception of our compatriots across the Tasman who are staring down the barrel of a 4.25 per cent cash rate, Australians are arguably facing the most challenging experience of rising interest rates in the world.

In April, the average new loan was written at a rate of just 2.41 per cent. Including the most recent interest rate rise, the average variable rate is now more than 3 per cent above that level in just seven months. Despite far greater rises in nominal interest rates in decades past, such as the move up to 17 per cent in 1990, in relative terms Australians have already experienced the largest single rate rise cycle in the nation’s history.

The generally variable nature of Australian mortgages and an extreme level of aggregate household debt has left households far more vulnerable to rising rates than most other nations. The expiry of fixed mortgages adds yet another challenging dimension, with many households coming off fixed rates facing paying 250 to 300 per cent of their previous interest bill.

While 30-year fixed mortgages may have higher rates in the long term and make US banks a fraction as profitable as those in Australia, it is times like this that many borrowers may have preferred the certainty of the same monthly payment for decades to come.

Tarric Brooker is a freelance journalist and social commentator | @AvidCommentator