If you’re paying off a mortgage – or aspiring to – imagine if you didn’t have to worry so much about rising interest rates.
That’s already the reality for US home buyers. Unlike in Australia, most mortgages in the US have a fixed-interest rate, locked in for 30 years.
Instead of having to wait and see if their central bank (the Federal Reserve) raises rates each month, a US 30-year fixed mortgage at 2% will still have the same monthly repayment – even after a rate rise.
In contrast, when the Reserve Bank of Australia lifts rates it has huge implications for household budgets, because most borrowers still have variable-rate mortgages.
Every time the cash rate increases and banks inevitably pass through that increase, our mortgage payments go up too – adding thousands of dollars to average annual repayments.
So why don’t Australian lenders offer 30-year fixed-rate mortgages too, like their US counterparts?
Every extra 1% can cost thousands
Here in Australia, an extra 1% on a A$600,000 mortgage means $6,000 a year more in interest payments. And these are post-tax dollars. So if you earn $100,000 and hence pay an average tax rate of 25%, that’s like taking a roughly $8,000 pay cut. Ouch.
A 3% rise in official rates over two to three years is not impossible. On a $600,000 mortgage that would mean an extra $18,000 a year in interest payments.
The RBA knows this, of course. It looks at Australian household debt of more than 120% of GDP and knows raising rates too aggressively risks putting a significant number of Australian households into financial distress.
In one sense this is good news. It means the RBA has large-calibre ammunition to fire in pursuit of its monetary policy goals (to keep unemployment low and inflation between 2% and 3%).
But it would be better if the Australian mortgage market involved less risk for consumers.
There is no reason why Australian lenders couldn’t offer 30-year fixed-rate mortgages. After all, there’s an active government bond market with maturities from one year to 30 years. This provides a benchmark to price mortgages.
Two fixes for more affordable mortgages
Fixed-rate mortgages have become much more popular in Australia in the past few years: the proportion of new mortgages that were fixed jumped from about 15% in June 2019 to more than 45% by September 2021.