Key Points
- As the contracts with low-interest rates approach their expiration, borrowers are expected to face increased monthly repayments.
- Experts encourage borrowers to engage in conversations with current lenders.
- Approximately 800,000 home loans, totaling $350 billion, are expected to transition from a fixed interest rate to a higher variable rate this year according to RBA.
Mortgage cliff
Many homeowners took advantage of historically low-interest rates by securing fixed-rate mortgages, providing stability and predictability in their monthly repayments. However, a new challenge has emerged for Australians as these fixed-rate loans come to an end, leaving them exposed to the "mortgage cliff" phenomenon.
The mortgage cliff cohort, referring to homeowners whose fixed-rate terms are expiring, will indeed face the challenge of adjusting to new repayment schedules that reflect the multiple rate increases implemented by the Reserve Bank over the past year.
Mortgage cliff can disrupt homeowners' budgeting plans, as they need to adapt to higher repayment amounts. This sudden adjustment may require cutting expenses in other areas or reassessing financial priorities to accommodate the increased mortgage costs.
Fixed Rates vs Variable Rates
Jerry O'Brien, a mortgage broker, director, and founder of Mortgage Station, explained the various options for home loans and how they can impact homeowners when the fixed rate expires.
"Variable rates, as the name implies, fluctuate. When the Reserve Bank of Australia (RBA) increases or when banks raise their rates, your rate and repayment will also increase. However, if rates decrease, your repayment will also decrease.
On the other hand, fixed rates, secure the rate at the time of application. For example, if you apply now and the average rate is 6%, and you secure that rate for 2 or 3 years, that will be your repayment for the next 3 years. The advantage here is that even if rates increase, you are secured and the rate won't go up because you entered into a contract."
Since 2016, Australia has seen the release of thousands of home loan options with temporary low-interest rates. Most of these low rates were offered during the peak of the pandemic.
According to estimates from the Reserve Bank of Australia (RBA), approximately 800,000 home loans, totaling $350 billion, are expected to transition from a fixed interest rate to a higher variable rate this year.
Jerry share's that this could cause a huge financial strain on many households.
"At that time, the fixed rate ranged from 1.9% to 2.5%. In comparison to the current rates, fixed rates now start around 6-6.5% and can go as high as 7%. So, going from 2% to 6% is a significant increase. Therefore, expect that repayments will increase. Let's look at it in terms of dollars.
For example, if your loan two years ago was around $500,000, your average monthly repayment was roughly $1850. Now, moving forward two years, when most fixed rates are expected to expire, the starting rate will be around 6%, with an average repayment of $3100 and above. That's an increase of $1,000 to $1250 per month.
Exploring options
Kreme Salvilla, a property investor and finance broker in Sydney advise borrowers to be cautious and explore their options when low-interest terms come to an end.
"Tighten your belt. So there are many ways to tighten your belt, like if you have unnecessary debts such as credit cards that can be closed or reduced, that would help too. And most importantly, ensure that your loan structure and finance strategy align with your investment goals."
While the mortgage cliff presents challenges, Kreme says homeowners can take proactive steps to navigate this period.
"Property investing is a long-term gain, and you need to make sure you can hold onto a property long-term.
To avoid selling the property, as general advice, I would suggest they seek help from their licensed professionals. They can consider reducing living expenses, such as eating out or reducing the number of holidays.
If they used to go on four local holidays a year, maybe they can reduce it. Another thing is they can negotiate with their current lender, especially if it's a variable rate, to potentially get a discount on the interest rate
Kreme further added that among these options is considering refinancing their home loan. By searching for another loan provider offering a lower interest rate, they may be able to reduce the increase in monthly payments and alleviate the financial burden.
Jerry also emphasized the importance of having experts provide advice before making financial decisions.
"It's very important to have an advisor by your side when it comes to finance matters. Not necessarily a financial advisor, although that would be beneficial, but credit advisors like us as finance brokers or bankers if you went directly to the bank. You can talk to them and say, "Look, this is my situation. What can we do?"
