Beware of Fixed Rate Mortgage Resets

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Earlier today, I showed how fixed rate mortgages have risen 14% (1 year) to 45% (five years) since last year’s low:

Now, Citi banking analyst Brendan Sproules is warning that average mortgage repayments could jump 25% to 35% as home loan specials reset:

While fixed rates protect borrowers against higher repayments, mitigating the initial effect of rate hikes, when fixed-rate loans expiring in the second half of next year are rolled over, annual interest repayments of around $27,600 on an average mortgage of $620,000 at a rate of 2% would increase to an annual repayment of $34,600 assuming a variable rate of 3.75%…

Before the pandemic, about 60% of new mortgages were variable rate and 40% fixed rate. But that has risen to about 80% of new fixed-rate loans over the past year. A relatively large amount of banks’ global mortgage portfolios have been created over the past 18 months as refinancing has surged.

“Therein lies the conundrum for Dr. Lowe,” Mr. Sproules wrote to Citi clients over the weekend. “If the RBA raises rates too quickly, 40% of the pound could suffer a sharp shock as their fixed term (usually two years) expires.”

The ABC’s Australian economics director, Gareth Aird, issued similar warnings last month:

The maturity profile of fixed rate mortgages means that over the next two years a very large proportion of mortgages will mature (see chart below for the expiration profile of the fixed rate mortgage portfolio of ABC). Based on the CBA’s fixed rate mortgage expiration schedule and its market share, it is likely that around A$500 billion of fixed rate mortgages will expire in Australia over the next two years. .

As the following chart shows, the median economist is tilting the spot rate to increase by about 1.25% by 2024, while the markets are tilting rates to increase by about 2.5%:

Currently, the average discount variable mortgage rate sits at 3.45% – well above the fixed rates underwritten earlier in the pandemic:

So, if the economists and/or the market are right, many fixed rate borrowers will face skyrocketing repayments when they refinance. In turn, the increased repayment burden (for new borrowers and refinances) would drive down house prices and slow the economy significantly.

For these reasons, I do not see the RBA raising the cash rate by more than 1.0%, as the impact would be too severe.

Therefore, expect little rate hikes and not before the end of the year, given that the mortgage market is already tightening regardless of the RBA.

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