What does the fixed rate home loan cliff mean for borrowers, property and economy?

These days, a lot of media attention revolves around the so-called fixed rate cliff — the thousands of mortgage holders whose repayments will skyrocket once their fixed rate terms expire in the coming months.

There’s no doubt that these borrowers will have some difficult decisions to make ahead of them. But what’s the likely outcome for the market and the economy more broadly? We take a look below.

First of all, what is the fixed rate cliff?

Before the pandemic hit, variable rate loans were overwhelmingly the more popular option among borrowers, making up around 80% of the mortgage market. Fixed rate loans, meanwhile, comprised just 20%.

That all changed in 2020 as the RBA’s emergency pandemic measures were rolled out. The cheap funding made available by the Term Funding Facility prompted banks to drop their fixed rates to record lows. This saw the share of fixed rate loans reach as high as 40%.

That number has since gone down to around 30%, but it’s still elevated compared to pre-pandemic levels.

So far, this cohort has been shielded from the RBA’s relentless rate hikes, but that won’t be the case for much longer: the RBA estimates that around two thirds of fixed rate loans will expire in 2023, meaning thousands of Australians will be flung into an interest rate environment vastly different to the one they’re used to.

Challenges ahead for borrowers

When borrowers locked in those ultra low rates two or three years ago, the serviceability buffer banks applied to their mortgage rates was set to 2.5% (this was bumped up to 3% in October 2021).

This was done at APRA’s request to ensure new borrowers could continue making repayments if rates went up.

But the variable rates borrowers will roll over to will be significantly higher than the ones they were stress tested for. Assuming lenders pass on March’s rate hike in full, the average variable rate in our database would jump to 6.10%. 

Do these borrowers have savings to help cushion the impact? The RBA has admitted it doesn’t have a clear picture of how much they’ve stashed away in recent years. 

Unlike variable rate borrowers, who are able to channel their savings into offset and redraw accounts, fixed rate borrowers often don’t have access to these features and can’t make extra repayments without attracting penalties.

But we can assume many fixed rate borrowers have set aside a tidy sum given the general increase in household saving rates over the pandemic period. What’s unclear right now is whether it will be enough.

Variable rate borrowers, who have endured a hefty but gradual increase in repayments, are facing a cliff of their own. A few months back, the RBA concluded that 14.6% of variable rate borrowers would have negative cash flow if rates reached 3.6%.

How these borrowers fare will come down to their banks’ financial hardship policies as well as how robust their support networks are. For example, some people might be able to move in with family and rent out their homes to receive supplemental income.

Will this lead to a recession?

ANZ senior economist Adelaide Timbrell said the fixed rate roll-off hasn’t had a material impact on household spending so far, but the picture will change around mid-year as rising rates and inflation cut into demand.

Fortunately, she believes Australia is well-placed to withstand the coming slowdown.

“A pause in per-person consumption growth has happened many times in the years before COVID, including in 2018. But it’s generally offset by Australia's population growing quickly, which is how the economy can stop growing on a per-person basis, but not on a total basis,” Timbrell said.

“The current economic pressures, including the impending fix rate roll-off, is very unlikely to cause a recession in Australia.”

What about the property market?

It’s one thing to avoid a recession, but what’s in store for the property market? Dwelling values have taken a serious hit since the RBA’s tightening cycle began, and though the pace of decline has slowed down as of late, it’s expected to pick up momentum as rates push higher.

Already, capital city prices have fallen around 10% since their April 2022 peak. In Melbourne, the gains from the pandemic period have virtually been erased.

A surge in distressed sales could put additional downward pressure on property prices. It would also be particularly painful for any borrowers who bought at the top of the property cycle and find themselves owing more than their homes are currently worth.

That all sounds pretty grim, but it’s worth recalling that high rates won’t be a feature of the economy forever. CBA economists suspect that the RBA will have to start loosening monetary policy by late 2023, so Australians might not have to endure these tough conditions for too long.

CoreLogic head of residential research, Eliza Owen said households have been resilient so far, but we won’t have a clear picture on how the fixed rate cliff will affect the property market for some time.

“Looking ahead, there’s no escaping that Australians with fixed-rate loans are about to see a painful adjustment. This is partly the intention of rising rates, as households have to curb spending in response to higher interest cost,” she said. 

“So far, listings data and arrears data suggest there is minimal impact on the housing market from defaults. However, the true test of the market will be over the next ten months.”

For more information on property and lending trends, visit our home loans statistics page. And if the rate you locked in is due to end soon, use our fixed rate ending calculator to see what your repayments might look like going forward.