Home owners use interest rate cuts to pay down mortgages
With retail spending remaining soft despite official interest rates hovering at 60-year lows, new research highlights why many retailers are finding conditions so tough despite the central bank's attempts to stimulate the economy.
When interest rates are cut, most borrowers are given the option of cutting their monthly repayment to free up cash or keeping repayments constant and paying back the bank more quickly.
Research from the Reserve Bank, published on Thursday, suggests most people are doing the latter.
Between 50 and 90 per cent of the savings of 2.25 percentage points of official rate cuts since late 2011 have been used for mortgage prepayments, it says, and this has been a significant drag on credit growth.
Previously the bank has said half of all borrowers are ahead of their mortgages, but has not measured just how much of the succession of rate cuts were being spent or saved.
The analysis provides an insight into why sectors such as retail have failed to see the bounce from low rates: because people have been using much of the savings to build up "mortgage buffers" instead of lifting their spending.
It also highlights the slower growth environment for the banks created by very cheap credit.
The amount of total housing credit would have grown by roughly an extra $10 billion in the year to July if not for people paying off their debts more quickly.
"In an environment where lending rates are falling, higher partial prepayments on mortgages reduce the rate of housing credit growth below what it otherwise would be," economists Marc-Oliver Thurner and Alexandra Dwyer wrote.
Estimates in the paper suggest the pace of housing credit growth in the year to June, at 4.6 per cent, was 0.8 percentage points lower than it would have been without the prepayment trend.
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The Reserve Bank found many homeowners used most of the windfall from recent interest rate cuts to pay down mortgage debt. Rather than increase spending, borrowers often kept repayments the same and used the savings to make extra mortgage prepayments, building up what the paper calls "mortgage buffers."
The paper estimates that between 50% and 90% of the savings from 2.25 percentage points of official rate cuts since late 2011 have gone toward mortgage prepayments. The RBA also said up to 90% of the windfall from the past two years of cuts was used to pay down mortgages ahead of schedule.
The research explains that instead of spending the money freed up by lower rates, many people used those savings to prepay mortgages or create mortgage buffers. That focus on debt reduction left retail spending soft despite official rates being at multi‑decade lows.
Higher partial prepayments reduce the rate of housing credit growth below what it otherwise would be, creating a slower growth environment for banks. The RBA notes very cheap credit combined with strong prepayment behaviour has been a drag on credit growth and bank lending expansion.
In the RBA’s context, "mortgage buffers" refers to extra payments or savings set aside against a mortgage when borrowers keep repayments constant after a rate cut. Those buffers effectively reduce outstanding mortgage debt faster and lower future loan balances.
The RBA estimates housing credit would have grown by roughly an extra $10 billion in the year to July if people hadn’t accelerated mortgage repayments. It also estimates the pace of housing credit growth in the year to June — 4.6% — was about 0.8 percentage points lower than it would have been without the prepayment trend.
The analysis was published by the Reserve Bank and written by economists Marc‑Oliver Thurner and Alexandra Dwyer. Their research examines borrower behaviour following rate cuts and the impact of partial prepayments on housing credit growth.
The findings suggest two implications investors should note: first, strong mortgage prepayments can dampen housing credit growth, which may slow revenue growth for banks compared with expectations under cheaper credit; second, when households use rate‑cut savings to reduce debt rather than spend, retail sales can stay soft even with low rates. These are trends — highlighted by the RBA — that can influence performance in bank and retail sectors.
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