The Reserve Bank of Australia (RBA), Australia’s central bank, warns of a $7000 Spike in Loan Repayments as interest-only term periods expire.
Every year for the next three years, up to an estimated 200,000 home loans will be moved from low repayments to higher repayments as their interest-only loans expire. The median increase in payments is around $7000 a year, according to the RBA.
What happens if people can’t afford the big hike in loan repayments? They may have to sell up, which could see a wave of houses being sold into a falling market. The RBA has been paying careful attention to this because the scale of the issue is potentially enough to send shockwaves through the whole economy.
Interest Only Period
In 2017, the government cracked down hard on interest-only loans. Those loans generally have an interest-only period lasting five years. When it expires, some borrowers would simply roll it over for another five years. Now, however, many will not all be able to, and will instead have to start paying back the loan itself.
That extra repayment is a big increase. Even though the interest rate falls slightly when you start paying off the principal, the extra payment required is substantial.
Loan Payments
RBA Unconcerned
For now, the RBA is unconcerned: “This upper-bound estimate of the effect is relatively modest,” the RBA said.
Good luck with that.
Mike “Mish” Shedlock
As explained in an article from the Bank of England, (link to bankofengland.co.uk ) “One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them.” Fractional reserve banking means banks create the money they lend at the time they lend it. They do not need a source of money to lend, other than having a small fraction as reserves. So there is nothing preventing the laws governing banking from stating that home mortgage renewals can never increase the interest rate on a mortgage. My question is why doesn’t that rule already exist.
I am not talking about interest-only loans and I’m not talking about the legalized gambling called variable-interest loans. I’m asking what the justification is for a system which uses “raising interest rates to slow borrowing” but does not exempt mortgage renewals, since those renewals are mandatory and those renewals are not going to affect the monetary supply. Why penalize mortgage owners because someone wants the economy to slow down? They are not the problem and cannot even choose to try to be part of the solution, because renewal is mandatory.
Mortgages rates for variable rate mortgages are lower than fixed rate mortgages, hence people take variable rate mortgages. Further, to maximise how much they can borrow, if you include only repayment on the interest only, your borrowing capacity is increased.
As Mish and others have said, when the next global recession hits, it will have a very large impact on Australian borrowers. Note we where not really affected in 2008. So we are cocky that our banking system is secure. Its not look at the current Royal Commission into the banking system problems.
I’m not talking about interest-only mortgages. The only thing I am questioning is why it is reasonable that the interest rate for a given mortgage should be allowed to go up at renewal time. It makes total sense to have a 25 year amortization, with shorter term loans, such as a 5-year term. That allows a customer to change lenders to get a lower rate. But I suggest there is absolutely no reason to have the interest rate go up at the renewal time of a mortgage. A higher interest rate does not have any effect on whether or not the loan will be renewed (it has to be) AND there is no change to the money supply. So there is no purpose to forcing a mortgage renewer to have to pay a higher interest rate.
In places like Australia and the UK mortgages are generally variable rate. It’s not like the U.S. where you can fix the rate for the life of the mortgage. Fixed rates are available in Australia/UK but 5yrs is typically the longest (banks are unable to hedge the interest rate risk economically beyond this period). In the example quoted in the article the mortgages are not renewing, they are re-setting (a bit like an adjustable rate mortgage does), although home-owners are free to look at what other lenders are offering, in which case, a new application has to be made, of course. The situation in the UK/Aust makes home-ownership much more risky because when the ‘fixed’ term rolls off you face the prospect of potentially higher rates. Obviously, rates have been trending down for decades but when the rate cycle eventually turns homeowners rolling off fixed terms into variable rates are going to be in for the shock of their lives.
Nothing worries the RBA. If you asked our RBA what would happen to the Australian economy if the lights went out because there was no more electricity, they would respond that there would be little, if any effect because electricity production represents less than 1% of the overall economy. Thats how these dickheads think.
Those were the known rules in Australia. Interest only periods expire.
What I don’t get is why a home mortgage renewal is treated as a whole new loan, subject to increased interest rates, as if the borrower had the choice not to renew. The purpose of raising interest rates, supposedly, is to cool down a heated economy by reducing the benefit of borrowing money. But mortgage renewals are mandatory. So why not exempt mortgage *renewals* from interest-rate increases? The interest rate should be allowed to drop for taking a longer term, etc, but renewals add no money to the economy, so banks should not be able to use interest rate increases to force foreclosures, which are actually theft of property, since they caused the default.