Most headlines I read nowadays are about how much the average loan repayment has increased by and will increase by for Australians. You don't hear or see too much of this headline for the US. Have you ever wondered why? The US mortgage system is a little different to ours. One of those differences is that most borrowers take out a fixed rate mortgage, typically for 30 years. Whereas in Australia, most loans are taken out on a variable basis.
In the chart below, we can see that about 90% of mortgages are fixed, and about 10% are variable. Looking back to the GFC, about 35% of mortgages were variable, the highest level we've seen over the last 33 years or so.
What this means is that a significant share of mortgages in the US are fixed. And fixed for a long time. Why does this matter? See Exhibit B (or 55) below. It charts the distribution of 30-year mortgages and their respective borrower interest rates. The horizontal axis shows us the interest rate, and the vertical axis shows us the percentage of mortgages that hold a fixed mortgage for the respective interest rate. For example, 15% of mortgages have a 30-year mortgage with an interest rate of about 2.90%. You can see 9% of mortgages have an interest rate of 3%. In fact, 38% of mortgages have an interest rate of less than 3%. Furthermore, about 78% of mortgages have an interest rate of 4% or less.
So what impact are the increases in rates in the US having on these mortgages? Not much. No wonder the US consumer still has a bit of money in their pocket. What does this mean? Securing such low rates for such long periods of time, means anyone with such a mortgage isn't budging. Meaning, they won't be looking to refinance, nor are they likely to be selling their home, because selling means you lose your great deal of a mortgage. As a consequence, we see a shortage in homes for sale in the US. No doubt, anyone applying for a new loan today will see their purchasing power deteriorate due to the rises in interest rates, but it also means they will be competing with bidders over fewer properties.
It's like shooting at a target that is wearing a bullet proof vest - not much damage (if any). This is of course having an impact for new borrowers as well as impacting the economy in different ways. Borrowers over the last few years have safeguarded themselves against the current rate rises. I'm sorry to say however, this is not the case in Australia. I wrote about this a few months' back here. We are fast approaching the "fixed-rate cliff". What happens from here is akin to that of the honeymoon rate expiration that triggered the US housing crisis back in 2008. I don't know what it is yet, however I know somewhere somehow it will be resolved, but right now, I don't have an answer. What I do know however, based on the information that is currently available, we're going to see a huge run up of refinances - to a level we've never seen before. In fact, for the first time, we are likely to see the value of external mortgage refinances surpass the value of new mortgage commitments as can be seen by the chart below.
Based on the pre-pandemic average, external refinancing accounts for around 26% of the total value of lending (ie new mortgage commitments + external refi). Based on the January numbers, external refi comprised about 46% of the total value of lending and is trending higher quite sharply. And I suspect banks will be fighting tooth and nail to win and hold onto their customers. Cash backs and discounts will be on offer. Let the games begin.
Jonathan Sim and I discuss this, and more in last week's The Wide Lens Podcast.
You can also listen to the podcast on Spotify.