How much the looming interest rate hikes could cost you

Borrowers who have stretched themselves to get into the hot housing market could see their mortgage repayments rise by hundreds of dollars a month if the Reserve Bank of Australia lifts rates in line with forecasts.

Analysis of recent property sales in the nation’s capital cities has revealed the potential cost homeowners are facing when interest rates do start to rise, which could be just months away.

The RBA is set to raise interest rates for the first time in 11 years. Picture: Getty

Jump to see the estimated cost for borrowers in each state

The RBA kept the official cash rate on hold at 0.1% at its April meeting, but many economists now expect a rate hike in June after RBA governor Philip Lowe dropped the phrase “prepared to be patient” from his post-meeting statement.

While many households already established in the property market have built up significant home loan buffers during the pandemic, PropTrack economist Angus Moore said newer borrowers were likely to feel the most financial pressure of higher interest rates.

“Obviously the impact of interest rate rises is not going to be felt equally,” Mr Moore said.

“More recent borrowers will be harder hit simply because they probably have larger mortgages and smaller buffers.”

“Similarly, different parts of Australia will feel this differently. Even though interest rates rise for everyone, mortgage sizes differ across the country, wages differ across the country,” he said.

Here’s a snapshot of what the big four banks are predicting:

Forecasts current at time of publication on 12 April 2022.

When the RBA raises the cash rate, lenders typically pass that on in full to customers with a variable interest rate home loan.

That means rate hikes eventually totalling between 1.25% to 3% would likely push variable rates up by the same amount.

However, the RBA typically increases rates in 0.25% increments, so reaching anywhere near those levels would take quite some time.

“It’s certainly not going to happen overnight,” Mr Moore said.

How much would that actually cost?

In Australia’s most expensive city, PropTrack data shows buyers paid a median $1.37 million for a Sydney house between December 2021 and February 2022.

Assuming a borrower had saved a 20% deposit, on top of other upfront costs like stamp duty, they’d have a mortgage size of around $1.1 million – costing around $4,342 in monthly loan repayments.

In this example the borrower is assumed to be on the average variable interest rate of 2.52%, according to January RBA figures.

Analysis conducted with the Mortgage Choice home loan repayment calculator shows that same borrower would need to fork out an additional $291 each month if their interest rate increased by 0.5%.

But economists are forecasting the cash rate could eventually peak anywhere from 1.25% to more than 3%.

Under the latter, that same borrower could be forced to pay more than $1,800 extra each month.

In this calculation, the borrower is an owner occupier paying principal and interest with 30 years remaining on their loan. It assumes an average variable interest rate of 2.52%, according to January RBA figures. The calculation does not factor in loan fees and charges, or any principal paid down over time.

It’s a similar picture in other capital cities.

Using the same method of analysis, Melbourne buyers who bought a house for the median sale price of $925,000 would have a mortgage size of around $740,000.

An increase of 0.5% to the cash rate could see their current monthly loan repayment of $2,931 increase by $197 each month to $3,128.

If rates were to jump by a full 3%, that $2,931 monthly repayment would surge by more than $1,200.

Borrowers who purchased recently could see their repayments rise by hundreds of dollars each month. Picture: Getty

In Brisbane, where buyers paid a median $740,000 for a house, a 20% deposit would result in a mortgage size of around $592,000.

With a 0.5% rate hike, those borrowers would need to find an additional $157 each month, or more than $1,000 if rates jumped 3%.

In Hobart, where house values have surged more than 20% over the past year, borrowers who paid a median $685,000 are facing an extra $337 a month if rates rose 1%, or $1,079 under a 3% hike. Recent buyers in Perth, Adelaide and Darwin could also be facing close to or more than $800 a month in extra repayments if rates grew by 3%.

In the nation’s capital, buyers paid a median $1.06 million for a house in Canberra between December and February. A mortgage of $848,000 could cost an additional $1,466 a month under an interest rate 3% higher than the average variable rate of 2.52%.

Given surging house prices have made saving a 20% deposit even harder over the past year, more borrowers have opted to take on lenders mortgage insurance (LMI) to get into the market sooner. As a result, some households would have even larger mortgages than estimated in this analysis.

House prices have outpaced units during the pandemic. Picture: realestate.com.au

Houses have significantly outpaced apartment price growth during the pandemic as work-from-home arrangements drove demand for more space, and border closures dimmed international demand.As a result, people who bought a unit in recent months are, on average, likely to have a much smaller mortgage than those who bought a house.

In Sydney, units sold for a median $780,000 in the three months to February, costing a borrower around $2,472 each month if they’d put down a 20% deposit.

If rates were 1% higher, that same borrower would need to find an extra $337 a month, or $1,079 if rates jumped by 3%.

Borrowers in Melbourne, Canberra and Hobart would need around $250 extra a month if rates increased by 1%, or roughly $800 more under a 3% hike.

Buffers to help, but not for everyone

During the pandemic, many households put away extra money into their savings and offset accounts, as lower interest rates freed up extra cash and travel restrictions limited the way they could spend their money.

According to the Australian Prudential Regulation Authority (APRA), the value of funds in offset accounts reached a record $232 billion in the December quarter.

Many borrowers have built up buffers, but many new borrowers haven’t yet had the chance. Picture: realestate.com.au

RBA governor Lowe told journalists last month that households were, on average, around two years ahead on their mortgage repayments, but acknowledged this didn’t apply to everyone.“So, that’s not to say there aren’t going to be problems, especially if interest rates have to go up by a large amount, but the buffers in the system have been built up,” Mr Lowe said

During 2021, more money was borrowed for housing than in any other year on record, as people took advantage of the record low borrowing costs and jumped into a rising property market.

It’s these new borrowers who haven’t had the chance to build up those buffers, and it’s these borrowers who are most likely to feel the financial pinch of a rate hike.

Household debt to keep a lid on rates

PropTrack’s Angus Moore said it was worth remembering that while interest rates will rise, increased levels of household debt would keep a lid on how high they go.

“We’re unlikely to reach anywhere near the cash rate peaks seen in previous decades, because inflation is just much lower today than it was then.” Mr Moore said.

“The Reserve Bank doesn’t move interest rates independent of the economy, it does so in response to conditions, so we’re not going to see the RBA raise interest rates more than it needs to.”

Australian households are among the most indebted in the developed world as a share of income, meaning even a small rate rise is expected to have a powerful impact on consumer spending.Given this, economists at the Commonwealth Bank think the RBA would only need to raise interest rates to 1.25% before having a contractionary impact on the economy.

“We conducted some scenario analysis to highlight the sensitivities of changes in the cash rate on mortgage repayments,” CBA head of Australian economics Gareth Aird said.

“Our work indicates that a cash rate of 2.5% would take mortgage repayments to their highest level on record as a share of household disposable income,” he said, noting records stretch back to 1999.

The message here, Mr Aird said, is that the corridor for interest rate rises is very narrow before it becomes contractionary on the economy.

“And the reason it’s so narrow is very simple – the record amount of household debt as a share of income means the impact of rate hikes on the household sector is greater than at any other point in time.”

CBA estimates more than one million home loan borrowers have never experienced a rate hike before.

Originally published as: How much the imminent interest rate hike could cost you.