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Interest rates have risen at a record clip during the past year, taking the Reserve Bank’s cash rate from virtually zero to an 11-year high of 4.1 per cent.
And yet indicators of mortgage stress are benign.
Rates of mortgage arrears remain low even though many home borrowers are under added financial pressure.Credit: Janie Barrett
The Australian Prudential Regulation Authority, which supervises banks, said in June the proportion of non-performing home loans “remained well below” pre-pandemic levels at 0.72 per cent of outstanding residential mortgages. A modest rise in non-performing loans in the March quarter followed seven consecutive quarters of declines.
A separate report by S&P Global Ratings said while the number of home borrowers behind on loan repayments had crept up, the overall share of mortgage arrears was “still below long-term averages”.
Australian households are among the most highly indebted in the world on some measures. So, why aren’t more home borrowers in trouble?
Jobs, jobs, jobs
Perhaps the biggest reason is sustained low unemployment.
In the past, a loss of income due to unemployment was the main reason for mortgage defaults. But the jobless rate in Australia has been at historic lows under 4 per cent for more than a year.
The robust demand for labour has meant that if a borrower lost work, finding alternative employment was comparatively easy. It has also allowed overstretched borrowers to take on more hours, or even a second job, to secure more income.
Erin Kitson, a mortgage market analyst at S&P Global Ratings, says historically low unemployment is the “first and most important reason” the rate of mortgage arrears is so low.
“In simple terms, there are more options there if borrowers are feeling debt serviceability pressures,” she said. “They can take on a second job, for example, to help.”
However, the Reserve Bank predicts unemployment will climb to about 4.5 per cent by the end of next year as higher rates hit the economy. That implies about 140,000 workers could lose their jobs over the next 18 months.
Another reason for the low prevalence of mortgage strife is the long period of favourable borrowing conditions before rates spiked.
The Reserve Bank’s benchmark cash rate, which has a strong influence on mortgage rates, fell to unprecedented lows below 2 per cent between 2016 and 2022 (and hit an extraordinary 0.1 per cent for the 14 months before May 2022).
Those figures allowed most home borrowers to get ahead on debt repayments. The Reserve Bank estimates that in early 2023 more than 60 per cent of all home loans “had balances in offset and redraw accounts equivalent to more than three months of their scheduled payments”. Almost half had buffers equivalent to more than a year.
The household savings ratio, which measures the share of disposable income being put aside, climbed to historic highs during the disruptions of COVID-19 in 2020 and 2021, bolstering the financial position of many.
Kitson says favourable financial conditions prior to mid-2022 helped households make the transition to higher rates, although the savings ratio has now fallen back to more normal levels. “There was a buffer there for a lot of borrowers to draw on which has probably delayed the impact of arrears going up,” she said.
A phase of fierce competition between home lenders also helped borrowers who took the opportunity to refinance mortgages at lower rates.
Falling off the cliff
Despite these advantages, many borrowers are now under pressure due to a dramatic increase in mortgage costs.
Modelling by Ben Phillips at the Australian National University’s Centre for Social Research and Methods shows since 2021 the average share of disposable income devoted to housing costs has jumped from 16.7 per cent to 25.1 per cent, the biggest proportion since at least 1984.
“The last 12 months have been pretty tough for mortgagors, perhaps the toughest in living memory,” Phillips said.
A large cohort of borrowers who locked in very low fixed rates face a big increase in debt repayments once their deals expire. This is known as the “fixed rate mortgage cliff” – about 880,000 borrowers will be affected throughout 2023 followed by another 450,000 in 2024.
S&P Global Ratings says the share of traditional mortgages (also called prime mortgages) in arrears climbed from 0.76 per cent in the December quarter of 2022 to 0.95 per cent in the March quarter 2023. Mortgage arrears are forecast to continue rising over the next six months.
Recent borrowers, especially highly leveraged first home buyers, are most at risk.
”The borrower cohort people are most concerned about is those with higher debt to income levels that bought at the peak of the property pandemic boom,” Kitson said.
“They are more likely to be first homeowners who haven’t had as long a time to build up saving buffers.“
The S&P analysis shows many neighbourhoods on the fringes of Melbourne and Sydney, where first home borrowers are common, have elevated mortgage arrears rates compared with other regions.
Kitson said “more and more of those types of suburbs” are appearing on the list of top postcodes for mortgage arrears.
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