Australia’s mortgage system is odd compared to the rest of the world, and that’s hurting Aussie families.
We’re exceptional in Australia. We’ve always known it. But exceptional is not always good. It can put you at risk of harm.
You see, Australia’s mortgage system is odd compared to the rest of the world, and that’s hurting Aussie families.
In Australia, we love the variable-rate mortgage. As the next chart shows, only the Norwegians use variable-rate mortgages more.
Note that Norway has slightly fewer fixed-rate mortgages than we do, but they tend to fix for longer – around four years, compared to around two in Australia.
To the US, both countries seem utterly alien. The idea of a mortgage with an interest rate that changes would make an American faint. If we lock in an interest rate, we gamble in locking them in for maybe two years at most. But in America, they think nothing of locking them in for 30. Imagine locking in your interest rate in the early 1990s (when they peaked at 17.5 per cent) and still paying it today.
There’s always refinancing
Of course, Americans aren’t fully locked in. They can refinance their mortgage. Banks let them pay off the whole debt without much in the way of fees, and then they can just get a new loan from another bank. But that works in one direction only.
Refinancing was widespread when rates were falling. People got themselves better and better rates. But now, when rates are rising? You’d have to be mad to refinance. Refinancing in America has shrunk to a tiny fraction of the market, according to data from the Mortgage Bankers Association. Better to stick with the rate you signed up for and let the bank suffer.
So, while Australians are facing a rate cliff, where our interest rates expire and we get a new higher rate with a new enormous repayment, the Americans are cocooned by their low-for-long interest rates. The banks who made those loans have to eat the difference.
As the next chart shows, the violent rise in official interest rates hasn’t hit American households particularly. They’re mostly paying the same rates they always were. In Australia, however, there was an enormous change.
How the heck can US interest rates work if they don’t crush household budgets? The answer is that they seem to work just fine at affecting inflation.
“[T]here is no evidence that the overall potency of monetary policy is any stronger in Australia than elsewhere,” writes the RBA.
That should give us pause. We are smashing the well-being of the one-third of Australian households with a mortgage, but it apparently doesn’t have to be like that?
So, how do US rate hikes work? They have their effect by changing the price paid on other types of loans and financial products. Bonds. Stocks. Corporate debt.
In Australia, it doesn’t work like that, partly because our financial markets are less developed. Corporate debt is low. Our corporate bond market is of a modest size. Our government bond market is big, but government spending doesn’t respond to interest rates in quite the same way.
And the stock market hasn’t been excessively harmed by the rise in rates, just as it wasn’t driven up excessively by the fall in rates in 2020-21. Our stock market is pretty stable, all things considered There’s a lot of patient superannuation money holding it up, scant leverage, and a fundamentally boring base of non-tech companies like Commonwealth Bank and BHP contributing much of the market capitalisation. So, we don’t get quite as much asset price effect through stocks.
Emergency fund: how much you need to save
An emergency fund is a great way to cover those unexpected costs that crop up because life can be unexpected. You might lose your job, your car might need repairs or you might get hit with a big dental or medical bill. But despite the best of intentions 1 in 5 Australians say they don’t have any emergency savings to fall back on at all. So how do you build an emergency fund – and how much should you aim to save? In a perfect world experts say that you should have 6 months salary stashed away, but if this just isn’t realistic for you – then set something that is – after all something is better than nothing.
Where we do get a price effect is in housing. Higher interest rates deter new purchasers and make house prices fall. Of course, our housing is also held by the household sector so that’s another burden that falls on households.
Ultimately, it means that when the RBA moves rates, the reaction comes from stressed mums and dads trying to make ends meet. When the US Fed moves, the reaction function comes from corporate treasurers and hedge-fund gurus trying not to disappoint the market.
Is that fair? That families are stuck trying to rearrange their affairs to help fix our economy? When it doesn’t have to be like that?
No wonder Australians are the most central-bank-obsessed country in the world. We’re the ones interest rates hit most.