Home loan borrowers in the outer suburbs of Australia's capital cities are vulnerable to an economic downturn

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  • Australian home loan delinquencies remain low by historic standards.
  • Delinquencies are higher in the outer suburbs of Australia’s capitals where mortgages have higher loan-to-income ratios.
  • Given some interest-only borrowers may soon have to switch to amortising loan repayments, the risk of delinquencies in inner-city areas is also increasing.

Compared to historic averages, the level of mortgage delinquencies in Australia are low, reflecting that mortgage rates have fallen substantially over the past decade, helping to keep monthly repayments low despite an increase in the average mortgage size.

Combined with stronger job market conditions in recent years, that’s helped to keep delinquency rates suppressed despite recent out-of-cycle variable mortgage rate increases announced by many Australian lenders.

However, while that suggests mortgage stress is at a minimum, there are some pockets of concern emerging, especially in the outer suburbs of Australia’s capital cities.

Across the country, delinquency rates in these areas are significantly higher in these areas compared to inner-city locations, according to a new report from Moody’s Investors Service.

“On average across Australian cities, mortgage delinquency rates are lowest in areas within five kilometres of central business districts (CBD) and highest in areas 30-40 kilometres from CBDs,” Moody’s says, pointing to the chart below showing the level of mortgages more than 30 days past due by distance from the CBDs of Sydney, Melbourne, Brisbane, Adelaide and Perth.

Moody’s Investors Service

So why are the proportion of loans overdue higher in outer regions?

Moody’s says that reflects that the greater the distance away from the CDB, average household income levels tend to reduce.

“In all Australian capital cities, average incomes decline with distance from the CBD, a fact that reflects the higher proportion of people employed in low-skilled jobs in these areas,” it says.

And given many younger home buyers, reliant upon debt rather than previous capital gains to fund their property purchase, have been attracted to these areas due to better affordability levels, Moody’s says that means “mortgage loan-to-value (LTV) ratios are higher on average in outer areas than inner-city areas, reflecting the lower average incomes of people in outer suburbs”.

“People on lower incomes have less capacity to make mortgage repayments above the scheduled minimum payments, which means loan amounts are paid down slower and LTVs remain higher.”

Moody’s Investors Service

Given the mix of low income levels and higher than average LVR ratios, Moody’s suggest these borrower are more vulnerable, in general, than those in inner-city areas.

“These factors increase the likelihood of mortgage delinquencies and defaults in outer areas, particularly in the event of an economic downturn,” it says.

“We expect delinquency and default rates to remain higher in outer suburbs for the foreseeable future, given these factors.”

However, that’s not the only risk Moody’s is monitoring.

Given the introduction of restrictions on interest-only (IO) mortgages from Australia’s banking regulator, APRA, in March last year — limiting the proportion to 30% of total new housing loans — Moody’s says this will increase the risk of delinquencies for borrowers in inner-city areas, particularly among investors in Sydney, Melbourne and Brisbane.

“The high share of housing investment and interest-only loans in inner-city suburbs poses a risk in these areas,” it says.

“In suburbs within five kilometers of the CBD in Sydney, Melbourne and Brisbane, at least 50% of mortgages are extended for investment purposes, while these areas also have a high share of interest-only loans.”

Moody’s Investors Service

While some maturing IO facilities have already converted to amortising repayments due to restrictions introduced by APRA, existing IO borrowers may face a similar scenario when it comes time to rollover their loan, raising the prospect of higher monthly mortgage repayments which will likely place upwards pressure on delinquency levels, particularly should home prices in these locations continue to decline.

“A large number of interest-only mortgages are due to convert to principal and interest loans over the next two years, which will increase the risk of delinquencies… [given] borrowers will have to make higher monthly repayments,” Moody’s says.

“In addition, the performance of investment and interest-only loans is more sensitive to housing price declines than owner-occupier and principal and interest loans, because borrowers rely on price gains to earn a return on their investment.

“Falling housing prices can also hamper borrowers’ ability to refinance such loans or extend interest-only terms.”

Despite the threat posed by higher monthly mortgage repayments facing some IO borrowers, Moody’s says delinquency rates in inner-city areas are likely to remain below those in outer suburbs even if the current price downturn lasts for a prolonged period.

“In the event of a prolonged downturn in housing prices, mortgage delinquencies and defaults could increase in inner-city areas with a high share of investment and interest-only loans, though in general we expect delinquencies and defaults to remain higher in outer suburbs,” it says.

NOW READ: The RBA appears confident that tougher home loan standards won’t impact the economy, but not every economist agrees

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