Where tighter monetary policy hits homeowners hardest

As central banks around the globe rapidly raise interest rates, policymakers outside the U.S. may find they pack more punch in terms of curbing demand.

• The reason boils down to the unique way Americans finance their homes.

Why it matters: Americans tend to take out mortgages with interest rates fixed over long periods, as much as 30 years. It means when the Fed tightens, most homeowners are unaffected.

• That's not the case in other countries in much of Europe, Australia and Canada, where spiking mortgage rates can result in higher monthly payments.

From the central bank's point of view, rate rises can cool demand in a very direct way.

• For example, the Reserve Bank of Australia did a sensitivity analysis showing that a 2.5 percentage point hike in rates caused an Australian family, with typical income and mortgage debt levels, to see monthly spare cash flow drop 13%.

Yes, but: That may be good for bringing down inflation, but it means economic pain for homeowners. The OECD warned recently that "low-income families in countries where households are highly indebted and variable-rate mortgages are widely used, such as some Nordic countries, could be particularly vulnerable" as rates rise.

Between the lines: In nations where mortgages are overwhelmingly of the variable type, "the required tightening and reduction in demand is spread broadly," says Krishna Guha, vice chair at Evercore ISI. "Rates might not have to go up as much because the increase hits incomes broadly."

How it works: When mortgage rates reset, homeowners tend to alter spending patterns in response, according to a paper released by the Dallas Fed earlier this year.

• It focused on Canada's housing market — where the vast majority of mortgages are considered "fixed-rate," which reset every two to five years. The findings have implications for other countries, where shorter-horizon fixed mortgages are common.
• When a reset resulted in a higher rate and steeper monthly payments, consumers didn't appear to pull back spending on big-ticket durable goods items. But there are signs they cut back elsewhere, including a corresponding decline in credit card balances.
• "From the accounting point of view, [it] means that they must have either reduced their other spending or their savings," Katya Kartashova and Xiaoqing Zhou, the paper's co-authors, said in an email.

Where it stands: As of the end of last month, about half of all variable-rate mortgage holders in Canada — those with fixed payments, roughly 13% of all mortgages — have reset at the level that would result in higher payments, the nation's central bank said last week.

• "These borrowers may need to adjust spending or use savings to meet their higher debt obligations," researchers write.
• Those who bought last year, when variable rates were at an ultra-low 1.5%, are facing the worst shock as rates approached 5% last month. Those monthly payments would have increased by about 20%.

The big picture: On the one hand, officials in these countries may see the effect of tighter money ripple through the economy sooner, as existing borrowers curb spending (thus slowing demand) as a result of higher mortgage payments.

• On the other hand, it means the burden of policy overwhelmingly falls on homeowners. The result could be political backlash: Philip Lowe, Australia's top central banker, today delivered an unusual apology to regretful mortgage holders who leaned on the central bank's early guidance that rates wouldn't rise until 2024.
• Economists have started to warn about "mortgage dominance," the idea that central bankers let up on aggressive interest rate hikes for fear of the impact on homeowners. As the Financial Times points out, Norway's central bank has downshifted rate hikes after a bigger-than-expected knock to its housing market.

What to watch: The problem may be most acute in the U.K., where rates recently soared amid broader market fallout from the failed tax cuts proposed earlier this fall.

• "A huge share of the tightening that the central bank executes will run through a massive income shock to 4 million or so households, on top of the cost-of-living crisis," says Guha. She estimates the total number of mortgage holders on a variable-rate or a two-year fixed mortgage is 4 million.
• "It's a huge distributional issue the central bank can't solve because it doesn't have the tools to do so."