Introduction
Banks do not offer 30-year fixed-rate
residential mortgages in Australia, unlike the United States (US). At the
height of the COVID-19 pandemic in 2020–21, a substantial number of Australian
borrowers took note of the ultra-low interest rates caused by loose monetary
policy, and sensibly locked in fixed-rate mortgages, with fixed-rate periods
typically lasting from 1 to 3 years. As interest rates have increased over the
past 12 months, these borrowers will likely experience large increases in their
minimum loan repayments when their fixed-rate periods end.
With borrowers facing this ‘mortgage
cliff’, and amidst fears that interest rates will rise further,
commentators such as Professor
Richard Holden and Tim
Fuller have asked whether Australian banks should start offering 30-year
fixed-rate mortgages to borrowers, which could insulate borrowers from big
swings in variable interest rates.
This Quick Guide discusses whether 30-year
fixed-rate mortgages would be a viable financial product in Australia, by
referencing experiences in the US mortgage market.
How many mortgages are on a fixed
rate in Australia?
Only a minority of Australian borrowers take
out fixed-rate mortgages (see Figures 1 and 2).
Furthermore, almost all fixed-rate mortgages
in Australia are short- to medium-term mortgages, with fixed-rate periods
typically lasting from 1 to 5 years. The ANZ bank and RAMS are the only major
lenders in Australia that offer 10-year fixed-rate mortgage products.
Figure 1 Total value of new home loans, variable versus fixed rate
Source: Australian
Bureau of Statistics, Lending indicators, data as at March 2023.
Figure 2 Proportion of new home loans that were fixed-rate loans
Source:
Australian Bureau of Statistics, Lending indicators, data as at March 2023.
Why don’t Australian lenders offer
30-year fixed-rate mortgages?
It may be riskier and less profitable for
lenders to offer long-term fixed-rate mortgages to retail customers, especially
if the Reserve Bank subsequently decides to raise its cash rate target, thereby
increasing banks’ financing costs.
A longer term fixed-rate period on a
mortgage typically exposes lenders to more risk. To compensate for the risk, a
10-year fixed-rate mortgage tends to have a significantly higher interest rate
compared with a variable or short-term fixed-rate mortgage (see the example in
Figure 3).
In the US, this risk is not borne solely by
lenders, but rather shared with government-sponsored enterprises which purchase
mortgages from the lenders (discussed further below).
The Australian mortgage market operates
differently. The risk is still mostly borne by lenders. Australian
lenders are therefore hesitant to lock in rates for 30 years, with the
knowledge that many fixed-rate mortgages will have to be held on their books
for the entire loan term – regardless of whether changes in the lenders’
financing costs later make these loans unprofitable.
Figure 3 Longer fixed-rate mortgages typically come with higher interest
rates
Source: RAMS, ‘Fixed Rate Classic Home Loan’,
examples of mortgage lending rates as at 23 March 2023.
Do lenders in other countries offer
30-year fixed-term mortgages? Why?
Lenders in the US offer 30-year fixed-term
mortgages to retail customers. In fact, the 30-year fixed-term mortgage is by
far the
most popular mortgage product in the US.
The US mortgage market is unusual in that
government-sponsored enterprises (GSEs) operate in the secondary mortgage
market. The two most prominent GSEs are the Federal Home Loan Mortgage Corporation
and the Federal National Mortgage
Association, popularly known as ‘Freddie Mac’ and ‘Fannie Mae’ respectively.
These GSEs do not issue mortgages to retail
customers. Instead, they purchase mortgages from lenders. From 2002 to 2020, approximately
54% of all residential mortgages issued by US lenders were purchased by
Freddie Mac and Fannie Mae.
By purchasing mortgages from lenders, the
GSEs assume the associated credit risk (associated with central bank’s interest
rates policy changes) and the liquidity risk (associated with being unable to
call in loan contracts at will). This partly explains why US lenders are
willing to offer 30-year fixed-rate mortgages, as they can simply transfer risk
to the GSEs.
In addition to the advantages for risk
management, these arrangements also create a regular source of new capital for
the original lenders. Lenders receive a lump sum of money when they sell their
mortgages to the GSEs, and this cash injection enables them to lend more
mortgages to customers.
The GSEs in turn transfer some of the risk
onto private sector investors. After purchasing a pool of mortgages from
lenders, the GSEs securitise these mortgages into mortgage-back securities
(MBSs) for sale on investment markets. Securitisation refers to the process
of pooling together illiquid assets (in this case, mortgages), repackaging them
into tradeable securities and then on-selling these securities.
Freddie Mac and Fannie Mae on-sell their
MBSs to institutional investors, such as pension funds and hedge funds. The
latter enjoy the prospect of a steady stream of income from the repayments made
on the mortgages underlying the MBSs. For the GSEs, the proceeds from
on-selling MBSs enables the purchase of more mortgages from lenders, creating a
self-reinforcing cycle in the US mortgage market (see Figure 4).
Given the GSEs’ outsized role in the US mortgage
market, the US federal government implicitly
guarantees them. This implicit guarantee allows the GSEs to raise funds at a
lower cost, further reinforcing this cycle.
Put simply, in the US the risk associated
with issuing 30-year fixed-rate mortgages is shared between lenders, the GSEs
and institutional investors through the mortgage securitisation process.
Figure 4 The GSEs’ role in the US mortgage market
Source:
International Monetary Fund, ‘Global Financial Stability Report:
October 2008’, 34.
Why doesn’t Australia have a
‘Freddie Mac’ or ‘Fannie Mae’?
There are no equivalents to Freddie Mac and
Fannie Mae in Australia. In the absence of GSEs, a handful of private sector
lenders and financial companies securitise some mortgages in Australia. As a
proportion of total value of outstanding mortgages, the market for securitised
home loans in Australia is much smaller than the US market.
During the 2008 Global Financial Crisis, Professor
Joshua Gans and Christopher Joye proposed that the Australian Government
create an ‘AussieMac’ (an Australian ‘Freddie Mac’ equivalent) to inject
liquidity into the Australian mortgage securitisation market. Australian
lenders – particularly regional banks and non-bank lenders – had trouble
accessing funding via the securitisation market at the height of the Global
Financial Crisis. In turn, their funding access difficulties limited their
mortgage issuance to retail customers and reduced
competition in the mortgage market.
Critics
of the ‘AussieMac’ proposal argued that the Government should not interfere
in the mortgage securitisation market, as the US experience showed that GSEs
could encourage both borrowers and lenders to take on excessive risk (known as
‘moral hazard’; for more details see the Parliamentary Library research paper
on ‘Financial
derivatives and their regulation’). GSEs could also become ‘Too Big to Fail’
and require a taxpayer
bailout.
It is unclear whether an ‘AussieMac’ would
substantially increase the amount of mortgage securitisation in Australia.
Although non-bank
lenders rely heavily on securitisation as a source of funding, Australia’s
major banks typically do not source large amounts of funding from securitised
home loans, as they can access cheaper funding from deposit inflows and the
bonds market.
Figure 5 Funding sources for Australia’s major banks
Source: Rachael Fitzpatrick, Callum Shaw and Anirudh Suthakar,
‘Developments in Banks’ Funding Costs
and Lending Rates’, Reserve Bank of Australia Bulletin, March
2022.
Other impediments to 30-year
fixed-rate mortgages in Australia
Borrowers who wish to refinance or terminate
fixed-rate mortgages in Australia are usually required to pay a prohibitively
high ‘break fee’; this discourages borrowers from signing up to fixed-rate
mortgages in the first place. This stands in contrast to the situation in the
US, where borrowers
are unencumbered by such break fees – but typically pay a higher interest rate
to compensate lenders for the extra risk.
Additionally, residential
mortgages in Australia are ‘full recourse loans’, which means that if a
borrower defaults, the lender can pursue all the borrower’s assets. In
the US, some states treat mortgages as non-recourse debt, meaning that the
lender can only pursue the loan collateral (usually, the house) in the case of
borrower default. In other words, Australian borrowers cannot simply ‘walk
away’ from fixed-rate mortgages that they can no longer afford.
Conclusion
The lack of an ‘AussieMac’, the diversified
nature of funding sources for Australia’s major banks and current mortgage fee
structures make 30-year fixed-rate mortgages unlikely to emerge in Australia.
For these mortgages to become a viable product, the Australian Government,
lenders and institutional investors would need to significantly develop the
local mortgage securitisation market.