Interest rates are a blow to borrowers as fixed rate loans decline
Over the years, I’ve cut my fabric (and, on occasion, my own hair) to accommodate my increased desire for more leisure.
But even armed with this somewhat extreme fiscal discipline, I’m starting to feel a little nervous about impending interest rate hikes. God knows how the rest of you are doing.
Fortunately, my home loan is fixed until the middle of next year at 1.84%. The downside, however, is that when my fixed interest rate expires and I switch to a variable interest rate, I – like many other mortgage holders – face a pretty significant cash flow shock.
Going even to the lowest variable rate available today would mean I would have to find an extra $600 per month. By Christmas, that amount will likely have reached $900 per month.
The size of my budget surplus last month? $843. In other words, without a change in my spending habits, I will soon be in the red.
It’s not a bloody story – I have a lot of fat to cut. I can give up my extra dues at around $800 a month (though I will miss those sweet, sweet tax savings). Next on the chopping block might be my $380 per month premium gym membership. I can also control my “eating out” budget, which exploded to $490 last month.
I can easily make sacrifices to pay my loan. This is largely because I didn’t borrow the maximum I was offered and was stress tested at slightly higher interest rates than newer borrowers.
Many more – especially borrowers who “rigged” their declared expenses when applying for a loan – will soon feel the effects.
I hope this is something our central bank policymakers keep in mind when adjusting rates.
Australian borrowers chaining themselves to big mortgages are also – often unwittingly – submitting themselves to being part of the central bank’s ‘monetary policy transmission mechanism’.
Changes in interest rates (also called “monetary policy”) act in several ways to cool the economy, including through their impact on asset prices and the currency. But the “cash flow” channel is one of the strongest and one that many borrowers are about to find themselves in – if they haven’t already.
Compared to other countries, a higher proportion of Australian home buyers tend to borrow through loans with variable interest rates. This has always provided our policymakers with a unique advantage, as their manipulations of borrowing rates quickly trickle down to household activity, either increasing or undermining purchasing power.
However, during the pandemic, an unusually high proportion of Australian borrowers have taken out loans at ultra-low fixed interest rates, which are set to expire within the next four years.
For variable rate borrowers, rate hikes are already effective. But for many, the pain is delayed, and today’s rapidly rising rates are likely to land like kings on their budgets for years to come.
Many financially competent households are already reducing their spending plans, ahead of what has been dubbed an impending “fixed rate cliff”.
However, many less financially literate households will only really feel the shock when they actually cancel their fixed rate loans. There is a higher than usual risk of even deeper spending cuts when they do.
For policymakers, this is an additional risk to the current economic outlook that should be given more weight.
For borrowers, there’s not much you can do except look for ways to increase your income or reduce your expenses.
We all have to be economists now.
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