Homeowners keep spending despite $1000 mortgage payment increase
UNSW Sydney
Australian homeowners shrugged off massive mortgage payment increases during the nation’s sharpest interest rate rises in decades, according to new research which challenges a key assumption about how monetary policy controls inflation.
Variable-rate mortgage holders absorbed monthly payment increases of around $1000 between mid-2022 and early 2024 without cutting back on spending, according to groundbreaking research that tracked real banking data through the Reserve Bank of Australia’s aggressive rate-hiking cycle.
The study challenges the conventional wisdom that economies with high proportions of variable-rate debt – like Australia – experience more immediate monetary policy impacts on household spending. Instead, homeowners maintained their consumption patterns by drawing down pandemic-era savings accumulated in mortgage offset and redraw accounts.
“2022 saw the most synchronised increase in interest rates across developed countries over the past 50 years,” said Dr Nalini Prasad, research co-author and Senior Lecturer in the School of Economics at UNSW Business School.
“These interest rate increases were designed to reduce inflation through restraining household spending. It is thought that monetary policy is more powerful in countries with more variable rate mortgage debt, like Australia.
“Here, changes in interest rates lead to immediate changes in mortgage repayments. However, we show that when mortgagors have accumulated savings, spending does not need to fall after interest rates rise.”
The study, conducted by researchers from UNSW Sydney, the e61 Institute, University of Sydney and University of Chicago, analysed de-identified banking data from 83,321 individuals between November 2020 and April 2024. During this period, the RBA raised the cash rate from 0.1% to 4.35% – a cumulative 425 basis point increase.
Mortgage holders tap savings rather than cut spending
The research found that variable-rate mortgage holders experienced a $13,884 increase in repayments relative to fixed-rate mortgage holders over the 18-month period following interest rate rises. Despite this substantial hit to household budgets, spending patterns showed little difference between the two groups.
Over this period, the study found variable-mortgagors experienced a $13,884 increase in mortgage repayments relative to fixed-rate mortgagors. “There was little difference in the spending and incomes between fixed and variable-rate mortgagors,” the researchers said in their paper, The Mortgage Debt Channel of Monetary Policy When Mortgages are Liquid.
The analysis showed that 70% of the increase in mortgage repayments was funded by homeowners drawing down their savings, with 26% coming from additional income sources. This consumption smoothing occurred because Australian variable-rate mortgages function as highly liquid assets through redraw facilities and offset accounts.
“An important feature of variable rate mortgages is that they provide a vehicle through which households can accumulate liquid wealth,” the researchers explained. Homeowners can make excess mortgage repayments without service costs, with any excess mortgage repayments able to be taken off the mortgage in the future, for example to fund consumption.
The redraw feature allows borrowers to access excess payments within one day, while offset accounts provide immediate access to funds that reduce mortgage interest charges.
Pandemic savings created rate rise buffer
The timing of interest rate increases proved crucial, occurring after households accumulated unprecedented savings during COVID-19 lockdowns. “Average repayment buffers have been large and increased substantially during the pandemic,” the study noted.
Before the pandemic, aggregate excess repayments averaged 26% of required repayments across the five-year period. This jumped to 42% of required repayments during 2020-2021 as lockdown restrictions limited spending opportunities and government support boosted household incomes.
The household saving ratio averaged 20% during the pandemic years compared to 7.7% in 2019, providing substantial buffers for mortgage holders when rates began rising.
The research found that 70% of variable-rate mortgage holders were making excess repayments before interest rates increased, with around one-quarter making excess payments of at least 40% above required repayments. However, this proportion declined to around 25% by the study’s conclusion as homeowners drew down their buffers.
Mortgage design trumps rate exposure
The findings highlight how mortgage market design influences monetary policy effectiveness beyond simple measures of variable-rate debt exposure. Australia has among the highest shares of variable-rate mortgage debt globally, with these loans historically accounting for 85% of new lending.
“Australia provides an ideal setting to study the transmission of monetary policy to household consumption,” the researchers noted, explaining that “the pass through of changes in the central bank’s policy rate onto variable mortgage rates is rapid, with interest rate changes typically passed on within two weeks.”
However, the liquid nature of Australian mortgages through redraw and offset facilities meant this rapid transmission did not translate into immediate spending cuts. “Consumption is sensitive to cash flows when high return assets are illiquid, which is not the case for mortgagors in Australia,” the researchers concluded.
The study examined various mortgage types, including combination mortgages with both fixed and variable components, finding consistent results across different specifications. “We find little change in non-durable, durable and services spending for variable rate mortgagors relative to fixed rate mortgagors,” the analysis revealed.
Central bank policy implications
The research carries significant implications for monetary policy effectiveness and inflation control. “Even in a country with a high share of variable rate mortgages, where the transmission from interest rates to required repayments is large and immediate, the effect on spending through increased required repayments need not be large,” the study emphasised.
“Increases in interest rates reduce available cash flows for variable rate mortgagors,” explained Dr Prasad. “But this doesn’t always translate into a slowing in spending. If spending does not slow, then this suggests that to reduce inflation a central bank will need to push more strongly on the monetary policy lever.”
The researchers concluded that institutional features making mortgages liquid “matter a lot,” with the effect of monetary policy on spending being “state dependent” based on accumulated savings levels.
“Our findings provide a cautionary tale,” the study warned, noting that monetary policy transmission through mortgage repayments may be weaker than commonly assumed, particularly when households hold substantial liquid savings buffers. As these pandemic-era savings are depleted over time, future interest rate changes may have more pronounced effects on household spending.
The research methodology employed an event study framework comparing spending patterns between variable and fixed-rate mortgage holders, using established academic approaches to measure consumption from transaction account flows.
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