Interest rates

I plan to have a YOLO Christmas before I hit a tax cliff

An extraordinary number of Australians are set to suffer a severe ‘mortgage shock’ in 2023 as they forego ultra-low fixed interest rate loans, often secured at rates below 2% at peak of the pandemic.

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From their ivory tower at Martin Place in Sydney, the Reserve Bank’s boffins are closely watching the reaction of borrowers. According to The latest RBA Financial Stability Review, only one in five home loans outstanding in Australia were at fixed interest rates before the pandemic – the rest being loans with variable interest rates. However, during the pandemic, that figure rose to two in five fixed loans, as borrowers took advantage of unusually cheap fixed rates.

The risk for the RBA is that those of us who have corrected are acting as if we are much more immune to the message the bank is trying to send, which is to stop spending so much and increase inflation.

We may be acting more like our American cousins, about 90% of whom have taken out 30-year fixed rate loans, making them much more optimistic about the US Fed’s aggressive rate hike campaign.

Unlike our American friends, however, Australian borrowers will soon be hit with a giant “fiscal cliff” at the end of fixed terms. About two-thirds of existing fixed-rate loans are expected to expire during 2023 (with a lucky third having fixed until 2024 or beyond).

Based on current market prices, this will likely cause the average mortgage interest rate to increase from 2% to around 5.5-6% for these borrowers (including myself). Ouch.

So should we save diligently and cut our cloth to meet our shackles of future repayments? Some households with very thin savings margins undoubtedly do and should do so, either by increasing their voluntary repayments or by adjusting their spending habits in advance. But for me, the answer is definitive: not yet.

As an avid student of optimal decision-making, I’m all too aware of my budget constraint. Over time, I’ve learned to make decisions that maximize my happiness from a given set of resources at all times. When my budget constraint changes, my decisions also change. For now, though, I’m heading into summer with my spending and vacation plans intact.

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If I’m the norm, that could imply a pretty sharp drop in household spending when fixed rates fall. I suspect, however, that this is not the case and that many will be tightening their belts a little this festive season, either by choice or by necessity for those already affected by rising prices and variable rates.

Of course, the bigger your savings reserve, the more you will be able to deal with fluctuating cash flows and smooth your consumption. Reassuringly, the Reserve Bank has observed that the cohort of borrowers who fixed during the pandemic have higher incomes and larger buffers than those who fixed historically.

So enjoy your hot girl and boy summers, my friends – plague and extreme weather events permitting, of course. Even RBA boffins expect a mini spending boom this summer as we embrace our long-awaited freedoms. We are only human, after all.

Jessica Irvine is a senior economics writer.

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