As many mortgage borrowers rework their budgets after the second interest rate hike in as many months, there are calls to reform Australia’s home loan market.
A new report this week from the Consumer Policy Research Centre (CPRC) and Mortgage Stress Victoria has highlighted how borrowers in many of our overseas peers have access to more affordable loans — thanks to much longer fixed terms for interest rates.
The problem with Australian mortgages
It said fixed-rate home loans that run between 10 and 50 years are common in Canada, Denmark, the United States of America, South Korea, and the European Union.
But in Australia, most Australians with a mortgage can’t predict their housing costs beyond a short time frame, because the vast majority have short-term variable loans.
It means households may have to pay hundreds, or thousands, of dollars more each month based on economic factors well outside their control.
Mortgages used as ‘shock absorbers’ in Australian economy
The report is Australia’s broken mortgage market: Practical ideas for better products.
It says longer-term fixed-rate loans would help families to better plan their finances, among other benefits, by providing more certainty and stability.
Under the current system, it says, Australian households with mortgages are used as “shock absorbers” for the Reserve Bank’s fight against inflation.
“Looking to international approaches to lending, Australia stands out as an anomaly where borrowers are treated as shock absorbers for the financial system,” it says.
“They take virtually all the risk and are offered limited product options or inconsistent support in times of hardship.
“Mortgages designed to keep costs low and stable could help more Australians afford to get into the housing market, and to keep on top of repayments once they’re in,” it says.
Anna Sri moved from Queensland to Darwin last year for cheaper living and said she didn’t know if a fixed-rate loan was an option for her when she purchased her town house.
Anna Sri says she moved to Darwin last year, because she could afford to buy a home there. (ABC News: Peter Garnish)
She took a variable-rate mortgage with an offset account, and she’s happy with the flexibility it has provided her, but says she knows others who have appreciated the certainty of fixing.
“I know some friends who have quite large mortgages, it’s definitely been better for them to have fixed rates,” she said.Â
“They just don’t have to worry about [rates] increasing for that period of time, so it makes it easier to budget.”Investors target high rental yields in booming Darwin market
Ms Sri says the Reserve Bank’s recent interest rate rises will impact her, but that’s just the system.
“It’s just unfortunate that housing is such a significant cost for people now,” she told the ABC.
“I don’t have kids or anything like that, I think if you had a family or you were trying to start a family it would be really stressful.”
Four ways to make fairer and cheaper home loans
The report says there is no perfect international model for fairer mortgages, but under Australia’s system borrowers are carrying too much of the risk relative to lenders.
It says Australia could do four things to create fairer and cheaper home loans.
Major banks respond to Reserve Bank cash rate increase
They are: long-term fixed-interest products, cheaper and more predictable variable mortgages, abolishing or reforming Lenders Mortgage Insurance, and introducing standardised hardship help for borrowers.
In September 2024, 97 per cent of the funding of new home loans in Australia were for variable rate mortgages, and just 3 per cent were for fixed-rate loans, according to Bureau of Statistics data.
At the moment, the report says, fixed-rate home loans in Australia are poor value and limited, with no competitive fixed-rate mortgages offered over 10 years.
It says most Australians choose variable-rate loans likely because the fixed-rate offerings “don’t stack up”.
“Long-term fixed interest loans of 20 or 30 years are not on offer for Australians,” the report says.
“When Australians choose fixed-rate loans, they typically lock in rates for two years or less.Â
“Most lenders only offer fixed-rate loans up to five years although a very small number offer fixed-rate loans for 7 or 10 years. These longer term fixed-rate loans are offered at much higher rates than shorter-term fixed offers,” it says.
Cheaper and more predictable variable mortgages
The report says most home loans in Australia allow banks to vary interest rates at their discretion, for any reason.
It says that “variable-at-the-bank’s discretion” approach shifts risks onto borrowers and gives borrowers little predictability about the conditions influencing when their costs rise or fall.
Nadia Harrison is chief executive of Mortgage Stress Victoria which has jointly released a report comparing Australian home loans to our overseas peers. (ABC News: Darryl Torpy)
It says when looking at the features of variable home loans overseas, there are two features that Australians would benefit from that they largely do not have access to today:
1) Tracker mortgages:
“Tracker mortgages” are variable rate mortgage products that promise to automatically track interest rates with movements in the RBA’s cash rate or to drop rates for existing customers if rates are dropped for new customers.
The report says these products mean that cash rate drops are more transparently and quickly passed on to customers.Â
Why mortgages aren’t in the CPI
Dr Andrew Leigh, Assistant Minister for Treasury, has been a long-time advocate of tracker mortgages.
2) Fixed payment loans:
This loan type involves variable interest rates, but payments remain static, with the borrower paying more or less on the principal of the loan depending on this adjustment.Â
It gives borrowers more certainty about their upcoming payments, although less certainty about the length of their loan and amount of interest paid over the life of their loan.Â
The report says that could be a good option for borrowers on fixed and low incomes, for whom payment predictability matters most.
Remove or reform Lenders Mortgage Insurance
The report is very critical of Lenders Mortgage Insurance (LMI).
LMI is insurance that is taken out by, and for, the lender, but it’s paid for by the borrower.
How to avoid mortgage insurance
Typically, Australian lenders require borrowers to pay for LMI when they are borrowing more than 80 per cent of the value of a property (i.e. they have a deposit of less than 20 per cent).
The report says LMI can lead to extra costs for borrowers who switch home loans, or act as a handbrake on some borrowers switching because of additional costs, among other problems.
It says LMI is particularly unfair when combined with Australia’s reliance on its current variable interest rate mortgage model because borrowers are bearing all the risk of defaulting and of increased interest rates.
“Australian borrowers get the worst of all worlds with LMI,” it says.
“Even with recent steps taken by the federal government to limit who pays LMI, this product remains poor value and likely unnecessary to manage risks in the finance market,” it says.
Variable-rate mortgages and monetary policy
At the moment, the “pass through” of the Reserve Bank’s interest rate increases to mortgage interest rates is faster in Australia compared to some other countries, given the higher share of variable-rate housing loans in Australia.Â
That was even true after the COVID-19 pandemic, when fixed-rate borrowing increased significantly for while.
Between 2020 and 2022, during the COVID-19 pandemic, when the cash rate target was cut to a record-low 0.1 per cent, fixed-rate borrowing jumped in Australia.
Many borrowers also fixed their interest rates for longer periods than is normally the case.
When the pandemic receded and the RBA began rapidly lifting interest rates from mid-2022, the large number of fixed-rate loans in Australia’s system delayed the effect of the RBA’s higher cash rate on borrowers’ cash flows.
But compared to other countries, the effect was still relatively muted.
Central banks in a number of comparable countries lifted their rates by more than Australia, but the pass through of the RBA’s rate hikes was still faster and larger in Australia, given Australia’s still relatively higher levels of variable-rate mortgages.
The pass through of the RBA’s rate hikes was also helped by the fact that the large number of fixed-rate mortgages in Australia were still only fixed for a few years, before they rolled over to much higher interest rates.