Interest rates are already rising in many countries and are almost certain to rise in Australia sometime this year. But how prepared are heavily indebted households, especially those who just paid top dollar for a home in the past couple of years?
Up to October last year, the Reserve Bank maintained a pandemic mantra that its "central scenario" was for rates not to start rising until 2024.
That's when Eliot Hastie and his partner bought a flat in the inner-Sydney suburb of Surry Hills.
"So, in October last year we weren't really looking," he says, before explaining that the Delta lockdown meant they weren't spending as much as usual, had built up a deposit and a flat they liked came up for sale.
"Just because of the situation of COVID, we finally could do it."
Like other buyers at that time, Eliot and his partner were also attracted by very low interest rates.
"Our fixed is just under 2 per cent and our variable is about 2.1 per cent," he says.
"But, already, I think that went up the day after we signed it."
Even before Eliot bought, the very cheapest rates in the market had already gone.
Despite the Delta outbreak triggering a quarter of economic downturn, analysts and markets were becoming increasingly certain rates would have to rise sooner than the 2024 flagged by the RBA.
Just after Eliot bought his apartment, in November the RBA's minutes dropped the date and merely said it was "prepared to be patient" on lifting rates.
Just a few months later, it seems that patience may be wearing thin.
US interest rates are set to rise on Wednesday for the first time since they were slashed during the pandemic, and Australia's Reserve Bank is a near certainty to follow at some point in 2022.
The Commonwealth Bank and some other prominent forecasters say the first move could be as soon as June to counter a surge in inflation that many economists, and even the Reserve Bank governor, are increasingly concerned could become self-perpetuating.
Ready for a rate rise?
An RBA rate rise would be the first in more than a decade, since November 2010, and some experts are concerned that millions of Australians are ill-prepared.
Analyst Martin North surveys thousands of households monthly about their financial position.
Even before Australian variable mortgage rates start rising, he believes a lot of them are under pressure.
"If I compare the number in stress now, [compared to] pre-COVID, it's up by 10 per cent," he says.
Martin North estimates that 1.5 million households with a mortgage are currently in financial stress, which he defines as spending more than they earn.
That's 42 per cent of mortgagors.
But this figure is much higher for the more than 2 million households that have taken out a loan or refinanced within the past two years.
Nearly half of them are already in stress, and North estimates that will rise to more than two-thirds if interest rates go up 2 percentage points from the current record low of 0.1 per cent.
Victoria has the largest number of recent borrowers already in mortgage stress, but New South Wales is more vulnerable to rising interest rates.
There are particular hotspots, focused mainly on new housing growth areas in the outer suburbs, like Narre Warren in Melbourne, Leumeah in Sydney, Tapping in Perth and Toowoomba west of Brisbane.
But you don't have to look much further down the list to see that mortgage stress is not only an outer-suburban problem.
"You then start to see some more affluent suburbs also being hit, for example Dee Why in the Sydney area," North observes.
"So this is an issue not just in those who typically extend themselves, first time buyers or those on the urban fringe, but there are other types of households who are also now feeling the pinch."
Inflation double-whammy
Barrenjoey Capital Partners chief economist Jo Masters says households already burdened with big debts are facing something of a perfect storm later this year, at least until wage growth picks up more strongly.
"We're going to see higher mortgage interest payments, we're also seeing higher fuel prices, strong inflation in rents, also food prices more recently," she explains.
The recent rapid rise in the cost of living has caught Eliot off guard.
"It's just not coming at an opportune time, I guess, when you think about all the other household expenses are all going up," he says.
Sudden talk of an imminent rate rise was also a surprise.
"When we were looking around [at properties], talking to people, talking to a broker, it was seeming like 2023, and now that seems to have rapidly changed," he says.
'$250 billion war chest of savings'
Many recent home buyers have done just that.
Tim Moore and his wife Leah are just about to settle on their first home in Canberra.
They started looking for houses in 2020 and, despite some banks initially seeming willing to lend them up to $1 million, they opted for a pre-approval of $750,000.
In the end, Tim says the townhouse they bought came well within that budget at $690,000.
They have taken out a variable rate mortgage, currently at 2.24 per cent, but, with two solid full-time incomes, he reckons they'll be "OK up to 6, 7, even 8 per cent" mortgage interest rates.
"We knew we were probably buying at the top of the market," Tim says, explaining that it was the right time for them to buy their own house after having their daughter.
"I'd much prefer higher interest rates and lower prices to ensure fairness across the generations."
Like Tim and Leah, Jo Masters believes most mortgage borrowers are well placed to weather rising rates and living costs after the pandemic.
"We've seen net household debt fall, we've seen households store up this $250 billion war chest of savings in cash deposits, and we've seen an extra $80 billion to $100 billion put into mortgage offset accounts," she observes.
"So, when we look economy wide, the household sector doesn't look dangerously leveraged.
"But, of course, that won't be true across all people that have gotten into the market."
That's precisely what worries Martin North.
"The average masks this really important difference that there are some households doing well, but there are many households that are not doing well," he warns.
Fixed rate rollover
Many borrowers have insulated themselves from rising interest rates by fixing their mortgages.
With lots of rates below 2 per cent last year, about half the loans written were fixed.
But it's only short-term protection, Masters cautions.
Munish, who took out a five-year fixed loan at 1.99 per cent when his family upgraded to a bigger home in Sydney's Hills Shire in February last year, isn't too worried.
The IT professional lived in the US before, during and after the global financial crisis, and says that's made him cautious about managing his debt.
"I do know that ultimately interest rates will go up," he says.
"The reason I can pay that is that I planned for that interest rate increase."
He is one of the majority of households who are either well ahead in their repayments or who have a large balance in their offset accounts, and he intends to use the savings from his sub-2 per cent fixed rate to build up that buffer more.
Denis Barnard and his wife recently bought back into the Perth property market a decade after selling out to move overseas.
They also locked in a cheap five-year fixed-rate mortgage, and so are not too concerned about interest rate rises in the short term.
But, even as a professional couple who took out a loan roughly half the maximum size they could have been approved for, Denis says they're taking steps to brace for much higher interest rates when their fixed loan period ends.
"We're questioning whether to do major upgrades on the house that we were considering," he explains.
"We'll pay off a huge chunk of the remainder of the loan so we won't get caught out [if interest rates rise a lot]."
But, again, not everyone has left this much wiggle room.
One Sydney mortgage broker says around 70 per cent of the loans he worked on last year were fixed for three years or longer.
But with ultra-cheap fixed rates gone and an increased interest rate buffer required by the banking regulator, that broker says a third of those clients would no longer qualify for their existing loan sizes if they were applying now.
Martin North argues regulators could still do more to reduce risky lending, with many people in the nation's more expensive property markets still borrowing more than eight times their income.
Others believe that extra buffer, implemented in November last year, will give recent borrowers plenty of breathing space.
"The fact that was raised to 300 basis points, that's larger than most forecasts of where interest rates may get to in terms of the rate hike cycle that we're facing," Jo Masters argues.
"So that will provide some safety within the system for the majority of borrowers."
We probably won't have to wait too long to find out who's right.
