Home loan borrowers have learned to take out longer fixed rate mortgage contracts. The 2021 incentive to lock in unusually low interest rates may change in 2022 to the fear of facing higher interest rates

By David Chaston

As we head into 2022, it is clear that home owners need to be prepared for higher mortgage interest rates.

In fact, the signals have been around for a while, and the latest RBNZ data (S33) shows that many borrowers have made an adjustment, taking out interest rate contracts with longer terms. Still, they are the minority.

During 2022, a whopping $151.0 bln is exposed to rate rises this year - and that is only for owner-occupiers. Investors have another $60.2 bln exposed to rate rises in 2022. (And there is another $3.9 bln exposed in mortgages taken out to support business loans.) That means that $215 bln will be rolled over in 2022 at sharply higher interest rates.

For every +25 bps rate rise, that is an extra annual interest cost of $537 mln. If we get two or three +25 bps rate rises in 2022, that could cost mortgage borrowers up to $800 mln. Almost all borrowers will be able to afford it. Banks have been diligent in ensuring they have stress-tested their customers (and especially their newest borrowers) for rate rises well above an extra +75 bps. But in turn, that will be $800 mln that will not be spent in the wider economy. Although annual retail sales exceed $107 bln, taking 0.75% off the top of that will be noticed. And the behavioural change as household tighten their belts with a crimped level of disposable income, could well mean there will be a multiplier impact.

Those that do roll over their mortgages in 2022 could follow the growing trend of taking out longer term rate contracts.

2021 started with 73% of household fixed mortgages due to be rolled over in the year, but ended with just under 60% like that. That is a big shift. Many cottoned on to the wisdom of locking in the very low rates that were on offer through much of 2021 and doing so for longer fixed terms.

Interestingly, investors made the same switch, but not as aggressively as owner-occupiers, taking their exposure to fixed rate contract from 77% rolling over within the year to 64%. Investors have stayed more short-term in their forward outlook.

The same data shows that the fixed term extension by owner-occupiers was away from the 2 year fixed, with more on three years, some more on four years, and a lot more on five year fixed terms.

The psychology might be slightly different in 2022. Rates on offer are no longer at record lows and have already risen about +2%. They are still 'low' in an historical context, but another +2% coming in the next year or two will put them back to the 6% range and more 'normal' from a longer term perspective. However, for some, a 6% home loan rate will be a 'shock'. So the drive to lock in current rates won't be so much as seizing on an unusual benefit, it will be more fear-based, trying to avoid a larger hit to the household budget.

Of course, many of those who did take advantage of the historically low 2+% mortgage rates only took them out for a one year term. And those that took them out early for a two year fixed term will also be facing a noticeable change in monthly payments as they contemplate 2022. Following their fellow borrowers into 3, 4 and 5 years locked-in options will seem like a good option to consider - if your housing situation is likely to be stable.

Floating rates are used by fewer borrowers now than at any time in our history. And in a rising rate environment, the use of floating rates home loans is likely to be driven even lower.

This story was originally published on Interest.co.nz and has been republished here with permission.