Attention Homeowners: Higher interest rates are coming

If households thought there were no consequences from Australia losing its AAA credit rating, they’d be wrong.

Homeowners will be the biggest losers if ratings agency Standard & Poor’s follows through and cuts Australia’s AAA rating – which is now on negative watch. The agency lower its outlook on Australia’s credit grade over concerns the government will continue racking up budget deficits without taking more positive action to rein in spending or increase government revenues.

S&P says fiscal position has continued to weaken with successive governments and with neither party commanding a majority in both houses, fiscal consolidation may be further postponed.

Australia’s biggest lenders – Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) were also put on notice and face the prospect of higher funding costs.

A ratings downgrade for Australia could see the banks’ ratings also cut.

They would then be forced to pay higher margins on their offshore borrowings – and those funding costs are likely to be passed straight through to borrowers. The banks rely on offshore bond markets for around 20% of their funding – the majority of funding still comes from customer deposits.

The last time the banks were faced with increased costs (October 2015), all of the big four raised their mortgage rates for all borrowers – the first time in five years, citing the higher cost of holding more capital. That came after the regulator imposed new capital requirements on the big four banks for residential mortgages and the banks were forced to issue billions worth of new equity to shareholders.

Any rate rises could be offset by the Reserve Bank of Australia – with the market pricing in a 70% chance of a rate cut later this year, taking the current cash rate below its current level of 1.75%. But with the banks’ net interest margins at low levels, there’s no certainty that the banks will pass on all or most of the cut anyway.

Foolish takeaway

With most Australian homeowners unwilling or too lazy to switch their mortgage away from the big four banks to a cheaper lender, the banks know they can raise rates with impunity.

Look out for higher interest rates on your mortgage.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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