- The RBA sees few signs that financial stress is building in Australia despite weak wage growth and high levels of indebtedness.
- It expressed confidence that tighter lending standards are helping to address building financial stability risks
- The bank is monitoring rollover risk for investors with fixed rate interest-only loans
Australian household debt has increased and wage growth remains weak, but that’s not yet led to a substantial pickup in financial stress.
And that includes households with a mortgage, be they owner-occupiers or investors.
That’s the concise view of Michelle Bullock, Assistant Governor of the Reserve Bank of Australia (RBA), who painted a rosier view of Australian household finances compared to other more pessimistic economic commentators in a speech delivered today. Bullock admitted that while pockets of financial stress do exist, they’re small and relatively stable in early 2018.
When it comes to those owner-occupier households with a mortgage, Bullock said there are currently few signs of a substantial increase in stress levels, pointing to a number of various indicators such as mortgage arrears, personal insolvencies and mortgage repayment buffers in her speech that suggest it’s well contained.
Here’s the current proportion of non-performing home loans in Australia.
This shows a significant and growing proportion of owner-occupier borrowers are currently ahead of their repayments.
“My overall interpretation of these myriad pieces of information is that, while debt levels are relatively high, and there are owner-occupier households that are experiencing some financial stress, this group is not currently growing rapidly,” she says.
“This suggests that the risks to financial institutions and financial stability more broadly from household mortgage stress are not particularly acute at the moment.”
As for housing investors, Bullock says the risks to financial stability are “probably a bit different from those associated with owner-occupier debt. Investors tend to have larger deposits, and hence lower starting loan-to-valuation-ratios”.
“They often have other assets, such as an owner-occupied home, and also earn rental income. Higher-income taxpayers are more likely to own investment properties than those on lower incomes, so may be better able to absorb income or interest rate shocks.”
Despite a comparably better starting position, Bullock says the preference from investors to use interest-only loans could lead to a pickup in financial stress should property prices fall for a prolonged period.
“Many take out interest-only loans so that their debt does not decline over time,” she says.
“If housing prices were to fall substantially, therefore, such borrowers might find themselves in a position of negative equity more quickly than borrowers with an equivalent starting loan-to-value ratio that had paid down some principal.”
While few expect an extended decline in house prices, seemingly limiting that risk, Bullock did warn that financial stress may build for some investors due to recent regulatory changes introduced by APRA, limiting interest-only lending to 30% of total new mortgage debt.
“The recent increases in interest rates on investor loans, in response to APRA’s measures to reduce the growth in investor lending, has probably affected the cash flows of investors,” she says, adding that “interest rates on outstanding variable-rate interest-only loans to investors have increased by 60 basis points since late 2016”.
Bullock also noted that the bank is 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 says.
“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, Bullock suggests that 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 says.
Combined with recent signals from owner-occupier borrowers, Bullock says that while there are some pockets of financial stress, “the overall level of stress among mortgaged households remains relatively low”.