- A record number of interest-only housing loans in Australia will expire within the next two years.
- Moody’s Investor Services expects that many borrowers will be forced to switch to amortising mortgages, increasing monthly repayments and delinquency rates.
- It says house prices will also determine delinquency levels over this period. In the year to July, nationwide home prices fell 1.6%. Many suspect prices will continue to fall over the coming years.
Mortgage delinquencies in Australia look set to increase over the next two years, according to Moody’s Investor Services, driven by a record level of borrowers being forced to switch from interest-only (IO) to principal and interest (P&I) repayments.
“When IO loans convert to P&I, borrowers have to make higher monthly repayments,” Moody’s says. “This “payment shock” can lead to mortgage delinquencies and makes IO loans riskier than P&I loans.”
And there’s a lot of IO loans set to expire within the next two years, explaining why Moody’s expects the level of bad debts will increase.
“A record number of IO loans are scheduled to convert to P&I in the next two years,” it says.
“Banks originated a significant volume of IO loans in 2014 and 2015. The five year IO period for these mortgages will end in 2019 and 2020.”
At current mortgage interest rates, Moody’s says monthly repayments on loans that convert to amortising repayments will increase by around 30%, something it says has and will continue to put upwards pressure on delinquency rates.
“The 90-days past-due delinquency rate for securitised mortgages that have converted to P&I after an IO period was at 0.94% in November 2017, double that of IO loans that have not yet converted and around 0.24 percentage points higher than the overall delinquency rate for securitised mortgages,” it said, pointing to the chart below.
Given what’s been seen so far, Moody’s clearly expects this trend will continue.
The group says the introduction of a 30% cap on IO loans as a percentage of all new mortgages from APRA early last year, as well as more stringent lending standards, has been the main factor behind the continued switch away from interest-only to amortising repayments, forcing many borrowers to move to higher repayments than originally anticipated.
“Regulatory measures introduced to reduce risks in the mortgage market have curbed the origination of IO loans, making it more difficult for borrowers to refinance their loans at the end of the IO period or extend the IO period for another term with the same lender,” Moody’s says.
“The more difficult refinancing conditions will contribute to an increase in mortgage delinquencies as the IO period on a record number of IO loans ends over the next two to three years.”
Along with potentially higher repayments, even with recent mortgage rate reductions from some lenders, Moody’s says future trends in home prices will also play a large role in determining delinquency levels in the period ahead.
“[This is] particularly in circumstances when borrowers need to refinance, extend the IO term or sell their properties,” it says.
“If house prices are declining when IO loan terms end, this will increase borrowers’ loan/value ratios and further limit their ability to refinance or result in a loss upon the sale of the property.”
In July alone, Australia’s median home price fell 0.6%, according to CoreLogic, leaving the decline over the past year at 1.6%, the steepest seen in several years.
The national decline largely reflects recent price falls in Sydney and Melbourne, Australia’s largest and most expensive housing markets, which have both seen values fall over the past year.
The weakness in those markets now appears to be spilling over into smaller capital city markets, and in regional areas, where price growth has either slowed or actually reversed in recent months.
Given the likelihood that tighter lending restrictions will remain in place, and with a large supply of new dwelling stock on the way and official interest rates already sitting at record lows, many are forecasting that prices will continue to fall in the period ahead, especially in Sydney and Melbourne.
Should such a scenario play out, at a time when so many IO loans expire, it suggests the risks to delinquency levels may be skewed to the upside.
Earlier this year, Michelle Bullock, Assistant Governor of the Reserve Bank of Australia (RBA), said the bank was monitoring what impact APRA’s changes may have on investors when it comes to refinancing existing fixed-term facilities.
“A large proportion of interest-only loans are due to expire between 2018 and 2022,” she said.
“Some borrowers in this situation will simply move to principal and interest repayments as originally contracted. Others may choose to extend the interest-free period, provided that they meet the current lending standards.
“There may, however, be some borrowers that do not meet current lending standards for extending their interest-only repayments but would find the step-up to principal and interest repayments difficult to manage.
“This third group might find themselves in some financial stress. While we think this is a relatively small proportion of borrowers, it will be an area to watch.”
Despite those risks from higher mortgage repayments and ongoing falls in home prices, Bullock said the vast majority of investors are in a strong financial position given stricter lending criteria implemented in recent years.
“Lenders have been assessing borrowers’ ability to service the loan at a minimum interest rate of at least 7%. So while interest rates and required repayments have likely risen, many borrowers should be relatively resilient to the recent changes,” she said.
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