Financial Stability Review – October 20235.2 Focus Topic: An Update on Fixed-rate Borrowers
Between March 2020 and January 2022, when interest rates were at their lowest, the share of fixed-rate housing credit almost doubled, nearing 40 per cent of housing credit outstanding (Graph 5.2.1). Since the first increase in the cash rate in May 2022, around 45 per cent of these loans (by value) have rolled off onto higher interest rates, with the vast majority of these borrowers opting for variable-rate loans.
This Focus Topic explores how borrowers who have already rolled off fixed rates have managed the transition and assesses the risks for the remaining fixed-rate borrowers. It finds that:
- The vast majority of borrowers who have rolled off fixed rates have managed the transition to higher interest rates well. Arrears rates among this group have increased a little, in line with the increase observed among variable-rate borrowers.
- The majority of current fixed-rate borrowers are estimated to have sufficient income to continue meeting their obligations after moving onto higher mortgage payments. The majority also have large savings buffers.[1]
- Fixed-rate loans yet to roll off do not appear materially riskier than those that have already rolled off. This group contains a slightly larger share of higher risk borrowers; however, these borrowers have also benefited from low rates for longer.
The vast majority of fixed-rate borrowers who have rolled off to date have managed the transition well.
Arrears rates for borrowers who have recently rolled off fixed-rate loans have increased slightly from low levels and are generally similar to arrears rates among other variable-rate borrowers (Graph 5.2.2).[2]
Arrears rates for borrowers who have recently rolled off fixed rates are also similar to those of other variable-rate borrowers when considered by borrower risk characteristics. Borrowers who took out (or refinanced) loans at low rates could be expected to be riskier given the larger increase in interest rates they face compared with other borrowers. However, arrears rates have remained low for these borrowers to date (Graph 5.2.3).[3] By contrast, arrears rates tend to be higher for borrowers with high ratios of loan-to-value (LVR) or loan-to-income (LTI), and moderately higher for first home buyers.[4] As might be expected, arrears rates are lower for borrowers still on fixed rates irrespective of their risk characteristics.
Arrears rates for borrowers who have transitioned from fixed to variable rates are higher for owner-occupiers than investors (Graph 5.2.2). This may be partly attributed to investors tending to have higher savings on average, and to the strong growth in rental incomes helping them to partially offset the increase in their borrowing costs. Investors are also more likely to sell an investment property before entering arrears compared with owner-occupiers, for whom selling their home can come with significant financial and personal costs.
Most remaining fixed-rate borrowers appear well placed to manage the transition to higher interest rates when their loans roll off.
This is supported by three factors:
- Fixed-rate loans yet to roll off do not appear materially riskier than those that have rolled
off already. However, there is a somewhat higher share of risky characteristics among
current fixed-rate borrowers than those whose loans have already rolled off. In part, this reflects
that these loans are generally newer, so borrowers have had less time to repay their principal (i.e.
reduce the size of the loan) and build up savings buffers (Graph 5.2.4). The majority of these
loans can be expected to become less risky over time; however, in the meantime they will likely be
more at risk if unemployment were to rise.
- Most fixed-rate borrowers are estimated to have sufficient incomes to meet their higher
mortgage payments and necessary expenses. Current fixed-rate borrowers are expected to
face slightly larger increases to their scheduled mortgage payments when their fixed-rates loans roll
off compared with those whose loans have already rolled off. As at July 2023, around
10 per cent of fixed-rate borrowers who have rolled off their fixed rates since May 2022
have faced an increase in their payments of more than 60 per cent. By comparison, around
14 per cent of current fixed-rate borrowers are expected to face an increase in mortgage
payments of more than 60 per cent when they roll off, based on variable rates as at July
2023. This in part reflects that a larger share of these loans were originated (or refinanced) at
very low interest rates during the COVID-19 pandemic compared with
fixed-rate loans that have already rolled off.
Nevertheless, the vast majority of fixed-rate borrowers have sufficient income to service these higher loan payments and meet their essential expenses. Around 7 per cent of fixed-rate owner-occupier borrowers are estimated to have their required mortgage payments and essential spending rise to be above their incomes after rolling off their fixed rates, based on baseline living expenses from the Household Expenditure Measure (Graph 5.2.5; see also Chapter 2: Resilience of Australian Households and Businesses). This estimated share increases to around 18 per cent when using a broader measure of expenses. - Most fixed-rate borrowers have substantial savings. Further supporting borrower
resilience, fixed-rate owner-occupier borrowers have benefited from lower interest rates during
their fixed-rate period and accumulated material savings buffers over that time (and in some
cases, added to their existing savings).[5] Around two-thirds of these borrowers have
liquid savings equivalent to at least 12 months of scheduled mortgage payments. This is
comparable to the savings of variable-rate owner-occupier borrowers (Graph 5.2.6). However,
there is also a smaller share of fixed-rate borrowers (less than 20 per cent) who will
roll off onto higher interest rates with much lower savings buffers, equivalent to less than
three months of scheduled mortgage payments.
Endnotes
See Lovicu G-P, J Lim, A Faferko, A Gao, A Suthakar and D Twohig (2023), Fixed-rate Housing Loans: Monetary Policy Transmission and Financial Stability Risks, RBA Bulletin, March. [1]
Earlier-stage arrears are also similar for borrowers who have rolled off fixed-rate loans and variable-rate borrowers. The level is higher for the share of rolled-off loans that are 30 days or more in arrears, at around 1.2 per cent, but liaison with lenders suggests that some of this reflects borrowers needing to update their payments rather than borrowers experiencing servicing difficulties. [2]
This is consistent with the analysis in 5.3 Focus Topic: Indicators of Household Financial Stress, which finds that a similar share of these borrowers have estimated costs of living in excess of income and similar savings buffers as other borrowers. [3]
For discussion of these risk factors, see 5.3 Focus Topic: Indicators of Household Financial Stress. [4]
Some borrowers were on variable-rate loans previously and already had large savings before fixing their rate. Fixed-rate borrowers are limited in their ability to save in offset and redraw accounts associated with their mortgages and therefore hold their savings largely outside of such accounts. While around one-fifth of recently rolled-off borrowers move over significant savings once they regain access to redraw and offset accounts associated with their new variable-rate loans, most keep their savings in their existing structures. This could reflect inertia or potential transaction costs (e.g. when selling shares). As a result, their saving buffers as measured by savings in their offset and redraw accounts (visible in the Securitisation System data) appear significantly lower on average than those of comparable variable-rate borrowers even a few months after roll-off. We are instead able to monitor their other forms of savings via private survey data as shown in Graph 5.2.6. [5]