Unmasking the ‘mortgage cliff’: Are recession fears overblown?
With all the talk of recession, we’ve been exploring its probability. As investors, it’s vital to understand which sectors and individual companies are most and least impacted. And helping in that task is appreciating the consumer’s important canary-in-the-coal-mine role. A consumer’s financial position will ultimately determine their propensity to spend on discretionary items and their ability to meet non-discretionary expenses such as utilities and the mortgage, so it is worth understanding each data point.
In a previous post, we noted helpful job creation (more than 850,000 in the past two years) and somewhere near $280 billion of accumulated savings. And while some analysts suggest mortgage interest payments over the next year will rise by approximately $40 billion, aggregate wage growth is forecast to grow by approximately $80 billion, an additional $25 billion will be received by consumers in the form of interest payments, and $24 billion in welfare payments from the government will also be received. According to these high-level numbers, households will be swimming in cash.
Fears of recession might be misplaced. But of course, the aggregates mask problems at an individual level. For example, the people incurring the $40 billion of additional mortgage repayments aren’t the same people earning an extra $25 billion in the form of interest income. Investors also need to appreciate that the marginal buyer or seller often drives outcomes for everyone. For example, if you aren’t buying or selling a house this weekend, you won’t contribute to house prices. Only the buyers and sellers this weekend – the marginal buyer and seller – will determine prices for everyone else.
And while PEXA’s latest Cash Purchases Report reveals over a quarter of residential property transactions in QLD, NSW and VIC were purchased outright without a mortgage attached, the report also reveals those buyers tend to be older and buying in regional areas where house prices are lower. They aren’t big contributors to Nick Scali’s, Adairs’, JB Hi-Fi’s or Harvey Norman’s financial performance.
For many businesses, their future is in the hands of the generations of younger homeowners, particularly those who purchased in 2021 and 2022, when house prices were higher and, therefore, with larger mortgages.
Together, many of them form what commentators call the “mortgage cliff”, with the peak resetting period commencing next month. Putting aside my personal view, that the number of mortgagees switching from fixed to variable rates is incrementally minor when compared to the total pool of mortgagees on variable rates who have already sustained and survived 12 rate increases, this cohort will need to meet new repayment schedules that instantly encapsulate a dozen rate rises from the Reserve Bank in just over a year. Many will move from fixed mortgage rates of around two per cent to above six per cent.
It’s worth appreciating any impact on the economy won’t be instant. Initially, many borrowers will meet their increased payments – even stressed households might be expected to sustain higher repayments, at least initially. But the longer interest rates stay high, the higher the number of households dipping into, and then completely eroding their savings.
So rather than expecting an immediate reaction, assume a slow and perhaps accelerating burn. Indeed, the Reserve Bank’s own transcript of the governor’s April Q&A, reveals the bank does not see a “cliff” but a “ramp-up”. The pressure builds over time rather than causing the economy to immediately fall off a precipice.
Along with the 880,000 expiring fixed loans in 2023, there are a further 450,000 due to expire in 2024 and beyond.
At the time of writing, the average owner-occupier mortgage is $576,985, and the consequence of the RBA’s rate rises is that a mortgagee will require an additional $1,250 more, after tax, each month or about $15,000 a year.
To put this in perspective, a recent report published by Canstar calculated a homeowner who purchased a property at the national median price of $818,000 in April 2022 could be paying up to $4542 per month when (if) the RBA cash rate hits 4.6 per cent. And this would require an astounding 55 per cent of the average after-tax income.
Homeowners who bought in 2021 or early 2022 are feeling the most pressure, given the higher property prices at that time and the greater borrowing power available due to then-record-low interest rates.
And the picture might actually be a little worse than that which Canstar paints.
While the average full-time annual earnings in Australia is $97,510, this figure is skewed upwards by the earnings of the top income bracket. In reality, the median income, representing the point where half of the population earns more and the other half earns less, is just $65,000 before tax.
In my estimation, rather than be concerned the banks will undertake a wave of repossessions and mortgagee-in-possession sales, the banks, the RBA, and APRA have a public relations nightmare on their hands. They will attend to it by working carefully with individual borrowers, just as they offered repayment holidays during COVID.
That might be good news for the economy in general, by saving it from a deeper recession. Still, it won’t be good news for those discretionary retailers whose target market is those younger, 30-something borrowers on strict repayment terms with their banks.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
