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Home loan customers are exploiting the very low cost of credit to get further ahead on their mortgages, giving them a protective buffer against a financial shock.

Amid all the warnings about the dangers of very cheap credit, this is a reminder that low interest rates aren’t just an opportunity to take more risk, they also give borrowers the chance to get on top of their debts.

When interest rates fall, borrowers have the option of paying the bank less each month, or leaving their mortgage payments unchanged and paying off the loan more quickly.

Figures from the Reserve Bank show that in aggregate, they are continuing to do the latter. Excess repayments have been gradually growing as interest rates have fallen.

This expands the borrowers’ “mortgage buffer,” which give them more breathing room before a default if they were to lose their job or suffer some other hit to their income.

The overall mortgage buffer has reached 16 per cent of all home loans, once mortgage offset accounts are included. That may not sound like all that much, but it’s equal to more than two years of minimum loan payments at today’s interest rates.

The buffer has expanded from about 10 per cent of all home loans a few years ago, and it means that many borrowers would have significant breathing room if they lost their jobs. Above all, it is a sign that many borrowers are managing their finances sensibly.

However, it’s also occurring at the same time as other warning signs are flaring up in the mortgage market.

For one, the closely-watched ratio of debt to income is high. Household debt to disposable income is about 150 per cent – near its highest level on record – and that increase has mainly been driven by the surge in house prices over the last couple of decades.

Delving into the data a bit further, the most recent increase in this ratio has been driven by investors, many of whom are betting on future house price gains.

The RBA is worried that this “speculative demand” is pushing up house prices to a level where they are at risk of falling significantly, which would harm economic growth.

These property investors who are using low interest rates to take bigger financial risks and push up house prices are worrying the regulators, who are looking to rein in riskier bank lending to property investors.

On the whole though, many borrowers appear to be responding to low rates by paying their bank back faster – and that’s welcome news.

The low level of interest rates means that most households can afford their loans now, but you should remember that rates are highly unlikely to stay this low in the long-term.

Therefore, paying off a bit extra each month can be a smart financial move.


Posted by Clancy Yeates – Money Manager (Fairfax) on 7th April, 2015