What happens when your bank sends you a rate rise alert?

It could be time to consider how you might fare should home loan interest rates rise in future. Analysts say there are currently some 1.5 million Australian households in mortgage stress, with one expert predicting even a small increase to their monthly repayments could tip them into severe financial pressure and see the emergence of ‘mortgage prisoners’.

Back in November 2010 was the last time the Reserve Bank of Australia increased the official cash rate. Home lenders largely followed suit by passing on mortgage rate rises to their customers.

The cash rate has fallen from 4.75% to just 0.10% since then, and while interest rates with many lenders have fluctuated during that time, some borrowers may not have received a note from their bank saying their interest rate would go up, and thereby their monthly mortgage repayments too.

While the RBA has so far remained steadfast in predicting a cash rate increase won’t occur until 2024 at the earliest, some industry experts and commentators think it could happen as early as next year. That could make a difference to the rate you pay on your mortgage.

In the meantime, Australians have been making the most of the cheap interest currently available by jumping on the real estate bandwagon, at a time when house prices have soared.

Whether a cash rate hike is a year or a few years off, have you considered how you and your household’s budget might fare with an increase in mortgage repayments?

Some borrowers to pay the bill for a higher cash rate

Finance sector analyst Martin North from Digital Finance Analytics said more than half of all mortgage holders in Australia currently have a variable home loan interest rate rather than a fixed rate, and they would be the ones likely receiving a rate rise notice from their lender if the cash rate goes up.

He expects existing variable rate customers would feel the pinch in particular from their bank, while cheaper ‘teaser rates’ would continue to be served up to new borrowers only.

Irrespective of what the cash rate is doing, there are already pressures on banks from the end of June this year, which is when their cheap funding from the RBA’s Term Funding Facility will run out. Canstar has already noticed several lenders increase longer-term fixed rates in the lead up to this.

The question is, how much elastic is in peoples’ budgets for a change to their home loan rate? Well, not much, according to Mr North’s analysis.

He said that on the whole, Australian borrowers have “really big” mortgages relative to their incomes and are very exposed to future rate rises, even though interest rates and repayments are low at this time.

His surveys show there are more people in mortgage stress right now than there ever have been before. Mortgage stress is when people struggle to meet their home loan repayments, and is an early measure of possible mortgage defaults.

“We’ve got 41% of households with a mortgage with cash flow problems at the moment – in other words, more money going out than money coming in,” Mr North told Canstar.

“So even small, incremental rises in those monthly repayments would be enough to put some households under even more severe financial pressure.”

He said 41% represented about 1.5 million households facing financial pressure right now. A rate increase of 1% would increase that number by another 100,000 to 150,000 households, according to Mr North’s analysis.

“Financially stressed people spend less, they tend to have to use their credit cards more because they’ve got bigger debts, and they tend to raid savings first – if they’ve got them – but that’ll run out eventually. All of these things will potentially be a drag on the broader economy as well as for the individuals,” he said.

He said over a two- or three-year period, many people under financial stress could be forced to sell their property if they couldn’t afford to repay their mortgage under a higher interest rate. And in the worst-case situations, banks could foreclose their property.

‘Mortgage prisoners’ could be forced to sell at a loss

Mr North said upward pressure on home loan interest rates could see the emergence of ‘mortgage prisoners’ – variable rate borrowers who would face a rate hike but have no choice but to either pay more or sell.

“While some are able to shop around and maybe find an alternative lender that has a better rate, if the market’s moving up you’ve got almost nowhere to hide, and quite a few people find it difficult to switch because sometimes their loan-to-value ratios aren’t particularly attractive to other lenders,” he said.

“Interestingly, quite often the people who are mortgage prisoners are younger households, they’re less well-educated households, they’re households with high leverage.”

He said mortgage prisoners could be forced to sell their property at a loss.

“If people bought a few years ago they’ve seen the price rise and so potentially they might sell into a rising market, but if you bought in the past 12 months you could be facing the situation where you’re selling into a market where other people are also selling and then prices are easing back,” he said.

He said if the forces that drove up prices – such as government stimulation and first home buyers “piling in at really low rates” – started to reverse, this could have a negative impact on prices.

In Westpac’s quarterly Housing Pulse report, released on Tuesday, the bank said it expected a 15% gain in property prices in 2021, slowing to 5% in 2022.

Play out this scenario: Can I afford a higher home loan interest rate in the future?

Mr North said that even if a bank tells you you can take out a huge mortgage right now, it’s worth considering how you might fare when rates inevitably go up.

“Play a scenario out and say well if rates went up by 1% or 2%, could I still manage those repayments?” he said.

“I think some people are swept up in buying a property if the bank says they can have a big mortgage at a very low rate, and they’ll jump on it and then don’t always think through the consequences. And unfortunately, the consequences pay later.”

Competition has been driving property prices well above expected sales values in recent months, and buyers have the option to lock in at record-low home loan rates.

There are currently 185 home loans on Canstar’s database with a rate below 2%. Borrowers who have secured these cheap rates have been urged to pay down their loan as much as they can before the tide turns.