Interest on a fixed rate mortgages is ticking up across the country as short-term borrowing costs rise for banks and markets increasingly expect the Reserve Bank to hike rates before the planned 2024.

Commonwealth Bank increased rates for its one through five-year fixed loans on Friday. It followed close on the heels of two earlier hikes by Westpac. Analysis by RateCity.com.au shows 33 lenders have hiked at least one fixed rate in the last month.

Banks are responding to higher borrowing costs. Yields on the three-year swap rate, which banks pay to borrow, more than doubled in the last month as the Reserve Bank bowed to market pressure and abandoned its policy of pegging 3-year bond yields to the cash rate. 

The jump reflects market worries about inflation and the belief that rates will rise faster than the RBA says. Bond markets are pricing in as many as three hikes to the cash rate next year, while the RBA continues to insist the next rate rise is unlikely to be before 2024.

The changes in fixed term rates are the leading edge of future interest rate changes and they come even as fixed-term loans have grown in popularity. In today’s Charts of the week, we look at the rapid rise of fixed term mortgages among the big four banks and what rising rates signal for borrowers, banks and the Reserve Bank.

Mortgages are increasingly fixed rate

Rising fixed rates comes at a time when fixed term loans have grown to a sizeable portion of Australia's mortgage market.

The share of big four home loans with a fixed rate rose from an average of 20% in fiscal 2019 to roughly 33% in fiscal 2021, according to data from each bank.

The shift was turbocharged by the pandemic. Cheap funding from the Reserve Bank made commercial banks willing to lend at fixed rates while borrowers were only too happy to lock in rates at what seemed like historically low levels.

In the last financial year, the share of fixed home loans grew by 10% at all three major banks except NAB.

Fixed term contracts let banks lock in customer relationships and retain market share but come with the risk that interest rates might rise and squeeze margins. During the pandemic, the Reserve Bank facilitated the rise of fixed-rate lending by offering the commercial banks billions at three-year fixed rates through its “Term Funding Facility”.

With fixed rates well below variable rates and seemingly unlikely to fall any further, borrowers refinanced, and new homeowners rushed in. The prevalence of low fixed rates may even have spurred a behavioural shift, reminding borrowers to shop around for a better deal.

The flood has only picked up into 2021. Between March and September this year, 52% of all new Westpac home loans were fixed rate. This year, almost half of all new mortgages across the big four banks were issued at fixed rates.

Banks balanced acquiring new customers with profiting off old ones. When the Reserve Bank cut rates to 0.1% last November, the big four banks cut fixed rates to draw in new customers but left variable rates unchanged.

We may be at the height of the fixed rate boom. Several banks have announced cuts to their variable rates while increasing their fixed rates. Lower variable rates let banks compete for market share while retaining the freedom raise rates should the interest rate outlook shift.

Fixed rates insulate homeowners and slow the Reserve Bank

With fixed rate mortgages on the rise alongside higher rates, what does this mean for borrowers, the big four banks and the Reserve Bank?

The first to feel the impact of higher rates will be prospective borrowers. Analysis by RateCity.com.au shows someone applying for a $ 500,000, 3-year fixed rate with CBA could potentially pay an extra $5,503 under the new rate.

The impact on the housing market is likely to be mixed. Some marginal borrowers may be put off by higher rates. Others could seize the chance to lock in rates while they’re still low.

Those already on a fixed rates mortgage are insulated for the length of their current loan. The expectation of higher rates at the end of the term could lead some mortgage owners to pre-emptively save, impacting how much cash is available for spending or investment.

On the other hand, fixed rate borrowers stand to benefit should inflation continue to surprise to the upside and force interest rates higher.

For banks, fixed rate mortgages make it harder to profit off interest rates changes. In offering fixed term mortgages, banks are effectively betting interest rates and/or funding costs will stay steady or fall. Where the opposite happens margins get squeezed, says Morningstar equity analyst Nathan Zaia.

“It means you have to wait longer before you can reprice your loan book,” he says.

Finally, the Reserve Bank may watch the trend towards fixed rate mortgages with some concern. When central banks hike rates, they are trying to change spending and saving behaviour throughout the economy. Research from the Bank of England showed that the widespread adoption of fixed rate mortgages delayed the impact of rate changes on households, slowing the impact of a major monetary policy tool.

For now, the RBA is more concerned about rising debt, with Governor Philip Lowe last week welcoming APRA’s recent decision to increase serviceability buffers on home loans.