Fixed-Rate Loans on Household Consumption and Financial Stability

During the COVID-19 pandemic, fixed-rate housing loans have become increasingly popular, with many borrowers opting for longer fixed-rate terms. Lenders have been offering lower fixed rates than variable rates to attract borrowers, aided by low-cost term funding from the Reserve Bank's monetary policy response. However, as rates have risen relative to variable rates, new fixed-rate lending has slowed. Most borrowers have rolled over to variable interest rates rather than re-fixing at higher rates. 

When borrowers' fixed-rate loan terms expire, their scheduled loan payments will increase based on current interest rates, and borrowers who had fixed-rate loans that expired in 2022 experienced an increase of up to 50% in their scheduled loan repayments. However, around two-thirds of borrowers experienced an increase of 30% or less. Loans that are yet to roll off their fixed rate will face a larger initial increase in scheduled repayments than those that rolled over during 2022. While many borrowers with fixed-rate loans may have saved or are saving to prepare for higher loan payments, some may have used the period of low fixed borrowing costs to consume more than they otherwise would have. 

Fixed-rate loans have slowed the transmission of a higher cash rate to mortgage payments, but the majority of loans are still variable rate and have already seen increases. Monitoring interest rates' effect on loan payments is crucial for the Reserve Bank, as it directly impacts household disposable income and plays a vital role in monetary policy transmission. Borrowers can manage their loan payments by cutting down on savings, utilizing existing savings or wealth, reducing consumption, or increasing their income. The difference between fixed and variable rates will gradually decrease as fixed-rate loans expire, and how well borrowers prepare for the increase will determine their ability to adapt without reducing consumption. 

Fixed-rate loans are riskier than variable-rate loans, and the increase in mortgage payments faced by borrowers with fixed-rate loans could lead to slower household consumption and potentially increase financial stability risks. Borrowers with fixed-rate loans tend to have riskier characteristics, such as high levels of debt relative to income and assets, low income levels, and low spare income after meeting loan payments and other essential expenses. Borrowers with fixed-rate loans are also more likely to have larger loans relative to their incomes or high loan-to-valuation ratios, especially for loans with low mortgage prepayments. This group of borrowers, especially those with low savings buffers, needs to be monitored as fixed-rate loans roll off in the period ahead. 

Borrowers' savings can help them adjust to higher loan payments, with many borrowers on fixed rates having built savings buffers, split loans, or accumulated savings in their mortgages. The bank will continue to closely monitor the expiry of fixed-rate loans, given its impact on the consumption outlook and financial stability. 

Source: https://www.rba.gov.au/publications/bulletin/2023/mar/fixed-rate-housing-loans-monetary-policy-transmission-and-financial-stability-risks.html