Rate hikes expose a tale of two borrowers

Warren Buffett famously said that it is only when the tide goes out that you discover who has been swimming naked. And there’s nothing like an aggressive tightening of monetary policy to expose the pink backsides of Aussie borrowers.

Yet the Reserve Bank (RBA) is seemingly unconcerned. Last Tuesday (19 July) RBA deputy governor Michelle Bullock gave a speech in Brisbane, giving a list of reasons why rising rates shouldn’t be an issue:

1. “Households have saved a large amount of money since the onset of the pandemic — around $260 billion," she said.
2. “Strong growth in housing prices over 2021 and early 2022 has boosted asset values for many home owners, with housing assets now comprising around half of household assets. The small decline in housing prices in recent months has only marginally eroded some of the large increases seen over past years."
3. “Among households with variable-rate, owner-occupier mortgage debt, around half have accumulated enough prepayments to service their current loan repayments for almost two years or longer. These payment buffers help to protect against the risk that, as interest rates rise, households will find themselves unable to meet debt repayments."
4. “The strength of lending standards in recent years gives us reason to be confident in the ability of many households to absorb some increase in interest rates," Ms Bullock outlined.
5. “The household sector as a whole has accumulated sizeable equity via higher housing prices over recent years.”

If half of borrowers are ahead on repayments, we can surely assume that the other half are not.

All that needs to happen for these borrowers is a major life event — a pregnancy, a birth, a death, an unforeseen expense — and things start to go awry. And that’s a pressure that simply hasn’t burdened those who bought 10 years ago.

While lending standards may have improved, the elephant in the room is a lifestyle and behavioural adjustment required in a rising rate environment. You simply need to buy less stuff when more money is going towards servicing debt. Fewer coffees, fewer trips away, fewer restaurant visits and Saturday morning café breakfasts. Throw in rising grocery costs, petrol prices and electricity bills and disposable income gets soaked up quick.

The RBA’s oversized rate hikes are also having a starkly different effect on different borrowers.

The buyer of a $500,000 Sydney home during the week before Christmas 2011 would have been paying a variable rate of 7.31 per cent if they borrowed from CBA. Let’s say they had a 10 per cent deposit, making the loan $450,000. Over 25 years, their monthly repayments were $3,271.

By Christmas 2021, 10 years after they first purchased their home, it was valued at over a million dollars, most likely on an interest rate no higher than 2.5 per cent.

Now let’s say a first home buyer purchased that same property in January 2022 for $1.2 million. With a 25-year mortgage at 2.5 per cent, their monthly repayments are $5,384. By July, their repayments have increased 100 basis points to 3.5 per cent or $6,008 a month.

On the current property price forecasts, by Christmas, the property would probably be worth $900,000 and monthly repayments would be approaching $7,000.

What does the next 10 years look like for this borrower? How much of a buffer do they accumulate over the coming years? How much equity?

If the RBA wants to discuss the impact of rising rates on home owners, they need to start showing us how the other half live.

James Mitchell is Head of Content at Momentum Connect. He designs and produces content for financial services companies of all sizes across Australia.