What Fixed Rate Cliff?
Updated: Sep 12
It was 2010. Collingwood had won the AFL grand final, and a week later, I was on a flight to Las Vegas. And yes, I was still wearing my Pies guernsey. I recall walking into a bank branch in Las Vegas to be shocked with an advertisement for a 30-year fixed mortgage with a 3 handle. Who would have thought that 12 years on, that 30-year mortgage rate would hit 2.65%?
Last week we saw the average of a 30-year fixed rate mortgage continue to rise, coming in at 7.23% which is a level not seen since June 2001.
Although current rates are higher than any point over the last two decades, they are even more elevated relative to existing mortgages. This is because many US borrowers have locked in insanely low rates. I wrote about this here and here.
As illustrated below, the spread between the current national average versus rates on outstanding mortgages remains at some of the widest levels since the late 1970s/early 1980s. In other words, for the bulk of those who already have a mortgage, a new mortgage at current rates would incur significantly higher costs. That gives them little reason to enter the housing market, and thus, is part of the reason for such scarcity in housing inventories.
Illustrated differently, below is the monthly payment of a median priced existing home assuming a 20% deposit using the current average 30-year mortgage rate versus the effective rate on all outstanding mortgage debt.
Based on this approach, the spread is even more blown out and has far surpassed readings from the late 1970s/early 1980s, and the incentive for an existing home/mortgage owner to move looks even worse. So why would they? Based on the current median price of an existing home and the current average 30-year fixed mortgage rate, the typical payment comes up to a little over $2,000 per month. Substituting that current 30-year rate with the effective rate on outstanding mortgage debt, the payment would be much lower at just $1,421 per month - or 34% lower!
Once homeowners have little reason to drop what would be low payments and re-enter the market, there is not much reason to believe that existing homes will hit the market in any meaningful way soon without a drop in mortgage rates. That makes new homes an increasingly important share of supply; a good environment for homebuilders. Homebuilder stocks—proxied by the iShares US Home Construction ETF (ITB)— in response continues to sit in an undisturbed uptrend. This month did see iShares Home Construction ETF (ITB) fall sharply and test that uptrend as it dropped back below its 50-DMA which formerly was offering a consistent level of support. But, that was short lived as ITB is fighting to push back above its 50-DMA today.
Australia, however, is slightly different. Our mortgages are typically fixed for 2 or 3 years. And we're right in the eye of the "fixed rate cliff" (yeah, remember that, it's still a thing).
So far, we haven't really seen much of an impact of expiring rates on the borrower or the economy. Don't get me wrong, there are stress bubbles around the place, but certainly nowhere near as high as the experts had predicted. And of course, we won't see much of an impact right now given the lags with not only the data releases, but also the time it takes for these things to flow through the system. CoreLogic recently published an article summarising this here. I too recently wrote a piece on lags here.
I've said this before and I'll say it again - personally I feel as though the worst of it is behind us, and of course, the market could prove me wrong very quickly. The reason I believe this is because of the positioning of corporates and the consumer coming out of the pandemic. Corporates and the consumer have never been better placed to weather the storm -cashed up, lower LVRs, higher incomes, more jobs, and the list goes on. And so maybe, just maybe, we end up somewhere in between a no landing and soft landing. And soon after well be hit with a tail risk than no one saw coming. And again, we look foolish for spending so much time on the risks that didn't eventuate. Until then, the debate continues.