When the Reserve Bank raised the cash rate to 2.85% this month, some mortgage borrowers were forced into a “stress test” limit.
- The Reserve Bank of Australia raised interest rates again this month, raising the cash rate to 2.85%.
- When the RBA hiked rates by 2.75% over a period of five months in 1994, it had been 28 years of such aggressive rate hikes.
- Mortgage repayments for the $500,000 loan now increase by $74 per month
What does this mean?
What is a mortgage “stress test”?
When evaluating someone for a new mortgage, a bank’s loan manager conducts a “stress test.”
They add a few virtual percentage points to the actual mortgage rate to help potential mortgage holders survive a series of rate increases.
The Reserve Bank of Australia’s (RBA) rate hike in November (by 0.25 percentage points) – the seventh consecutive increase since May – means the cash rate is at its highest level since April 2013.
This latest rate hike also means that many borrowers have reached the limit of their ability to pay, with some exceeding the “stress test” buffer.
What does the recent rise in interest rates mean for borrowers?
The RBA’s own projections had previously shown that a 2% rise in interest rates would push 10% to 20% of all households into mortgage stress, according to economist Angela Jackson.
Cash rates are now even higher.
“This has left quite a few households in debt stress,” she says.
In effect, a $500,000 mortgage with 25 years remaining on the loan would increase your monthly payments by an additional $74. That’s a total increase of $760 since rate hikes began in May.
For a $750,000 loan, the borrower would pay an extra $112 per month.
Dr. Jackson said a major concern for many borrowers is the move to negative equities.
That’s when the home’s value falls below the loan amount. This could lead to a forced sale to allow the bank to recover the money.
“We know many borrowers are under severe financial stress,” warns Dr. Jackson.
Rate hikes have happened before
The last time interest rates rose so aggressively was 1994It increased by 2.75% in five months when the central bank raised interest rates from 4.75% to 7.5%.
Journalist and academic Jenna Price told Drum that she was paying off her mortgage in the early ’90s and cried every time interest rates were raised in 1994.
“Every time there was a new interest rate, I would be totally upset about my mortgage,” she says.
“We decided to buy a three-bedroom house, which we really couldn’t afford. We also built another bedroom, which we really couldn’t afford.
“This is what happens when you have three kids. I panicked.”
However, she decided to take control of the situation and consult the bank.
“What kept me going was the realization that I had some power over my bank,” she says.
“We must have changed banks about five times in five years.
“Call your bank, go to your mortgage broker, and look at comparison sites.”
Will interest rates fall again?
To keep inflation down, the RBA raises interest rates, reducing demand in the economy and making borrowing more expensive.
The only way interest rates will fall again is if inflation falls.
The RBA and federal government insist they are doing their best to get there, but the federal Treasury secretary has warned that inflation is likely to get worse before it gets better.