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Mortgage borrowers are being warned to brace for variable interest rates to potentially rise even more than the official cash rate increases.
Key points:
- Banks have to refinance $188 billion in cheap RBA loans by mid-2024
- Depositors have not yet seen the full benefits of RBA rate rises passed on, nor mortgage holders the full costs
- Analysts warn there could be up to 0.2 percentage points of rate rises above the RBA's moves
So far, the Reserve Bank of Australia (RBA) has lifted interest rates by 3 percentage points. Many lenders were quick to pass on the increases, in full, to variable home loan customers, but were slow to do so for savers.
Many economists predict that there will be at least two to three more rate hikes before the RBA pauses later this year.
The RBA has been trying to curb surging inflation — which is expected to have peaked at 8 per cent at the end of 2022 — by very quickly lifting interest rates from a record low to their highest level in a decade.
And new, rolling monthly CPI data from the Australian Bureau of Statistics (ABS) released this week confirmed that inflation was yet to be tamed, rising by 7.3 per cent over the 12 months to November.
However, even after the RBA stops hiking rates, home loan borrowers could still see their mortgage rates rise further, as banks are facing soaring funding costs while trying to protect their profit margins.
Why are bank funding costs rising?
Banks need to borrow money to back the loans taken out by their borrowers, and that comes with costs.
There are different ways of raising money for the banks. For example, they can lend from depositors (through savings accounts and term deposits), from the central bank or from international wholesale debt markets.
And all three of these funding costs are about to get more expensive, due to different factors.
During the pandemic, banks had borrowed $188 billion of three-year emergency loans from the RBA at fixed rates as low as 0.1 per cent.
The big four banks alone account for $132 billion of that total amount.
That helped to slash the rates on fixed home loans to record low levels.
The loans provided by the central bank were issued under its Term Funding Facility (TFF).
About $85 billion of the TFF matures, or expires, in the 2023 calender year and the rest is due to be repaid by the June quarter of 2024.
The end of this cheap money will place some upward pressure on bank funding costs as it has to be replaced with much-more-expensive deposit and wholesale funding.
PwC Australia's banking and capital markets leader Sam Garland said that the rising rate environment in Australia, and around the world, was naturally flowing through to increased bank funding costs.
"We are coming out of an ultra-low rate environment where a large proportion of deposits — which are generally the lowest cost and make up around 70 per cent of major banks' funding — were paying very low interest rates, to an environment where competition for deposits will naturally increase," Mr Garland told the ABC.
Digital Finance Analytics principal Martin North agreed. He said that funding costs were under pressure from higher international bond rates and competition for deposits.
"Banks have been switching more to deposits in recent times but have not been passing on all the cash rate rises to savers. This is a source of managed margin expansion," he told the ABC.
"This offsets the tighter margins as old cheap bonds run off and are replaced with more-expensive-now ones."
Apart from that, analysts from Barrenjoey are expecting banks to see a 5-8 per cent rise in their operating costs as inflation pushes up wages bills and expenses, adding more pressure to profit margins.
How will increased funding costs impact mortgage rates?
Australia's big banks raked in nearly $30 billion in 2022, but they are facing a tougher 2023.
As the costs of bank funding rises, mortgage interest rates will likely rise as banks seek to recover their increased costs.
However, Mr Garland said, any increase beyond the RBA's cash rate rises would likely be tempered, because rising rates were already driving down house prices and demand for credit, increasing the level of competition for mortgages in a less-buoyant lending market.
New figures released this week by CoreLogic show that Australian home values have seen their biggest decline on recent records.
Mr North said, although the impact of increased funding costs on mortgage rates was likely to be marginal in near term, if the RBA continues to raise rate and international funding costs remain high, banks may be forced to pass on more than cash rate rises to mortgage holders or keep savings rates on hold.
"They will offer cheap loans to new borrowers and refinancers, so I would expect the bulk to be passed to existing borrowers, in terms of higher rates," he said.
"Something like 20 basis points, at worst, is possible, but it depends on market rates and competition, and deposit substitution."
Canstar group executive financial services Steve Mickenbecker said banks were yet to be under the same pressure as smaller, non-bank lenders were, because they have large savings account balances at their disposal.
According to data provided by Canstar, at least nine non-bank lenders have already increased variable rates by more than the RBA's 3-percentage-point cash rate rise since May 2022, due to their reliance on wholesale funding.
What can customers do about it?
Meanwhile, Nano Home Loans quit taking new applications and Volt Bank surrendered its licence last year after failing to raise capital to support its plans to write mortgages.
"[Non-bank lenders] don't have retail savings accounts and are wholly reliant on wholesale markets for their funding, putting them under pressure as rates have risen," Mr Mickenbecker said.
"By holding back interest rate increases to savers, the banks have been bolstering their margins and building a war chest to deal with the refunding of the 0.1 per cent TFF.
"However, if the ACCC review forces savings interest rates up, on top of the need to refinance the cheap Reserve Bank, three-year COVID emergency funding, the banks too could find themselves having to increase rates more than the Reserve Bank."
If that happens, it will add pressure to some borrowers who are already at risk of defaulting on their mortgages and many others who are rolling onto variable rates from fixed rates later this year.
It also means that, potentially, there will be more bad debts for banks, which require more capital and will trim margins further.
"It's likely bank profits will take a net hit, but I would also be watching for the imposition of additional fees and charges to offset margin compression," Mr North said.
"Also, some borrowers with high [loan-to-value] loans may be charged more, they will balance the 'risk premium'."
Mr Mickenbecker said new customers should shop around for better variable rates and savings rates.
"The average interest rate is still way above the best deals around and borrowers need to compare and look for a better deal," he said.
"Savers can't wait for their bank to lift rates but should take advantage of the better deals around, which can be almost 2 per cent above the average."