The UBS banking team has highlighted another potential red flag in Australian housing, interest-only loans, and more specifically, the number of borrowers who don’t actually know they have one.
The latest note follows their “Liar Loans” research about inaccurate mortgage applications, which was based on a survey of 907 mortgagees around Australia.
The team took another look at the data and one thing stood out:
“Of the 907 respondents only 23.9% by value stated they were Interest Only (IO). This is substantially lower than the APRA system statistics at 35.3%,” UBS said.
Having double-checked the statistical robustness of the sample, the analysts took a closer look at the cause of the discrepancy:
We believe the most likely explanation for the lack of respondents indicating they have IO mortgages is that many customers may be unaware that they have taken out an interest only mortgage. In fact, our survey suggests that around a third of interest only borrowers do not know that they have this style of mortgage.
The team noted that some may consider their conclusion “far-fetched”, however they said the result was concerning when placed against the backdrop of two broader themes:
1. The lack of financial literacy in Australia; and
2. The implications of high household debt levels amid tighter lending conditions and a market that’s showing signs of cooling.
UBS cited a recent survey by ME Bank which found that 60% of Australian respondents failed a basic literacy test, and 38% had no understanding of interest only repayments.
They said such a lack of literacy would be less concerning if Australia didn’t have a record-high level of household gearing.
Furthermore, for the one third of borrowers UBS estimates don’t know they are only paying interest, an unexpected 30-60% jump in mortgage repayments is on the cards at the end of the interest-only lending term.
Of the respondents from the UBS survey who were aware that they had an interest-only loan, 71% said they were either under moderate or high repayment stress.
When asked how they would respond to that stress, more than half said they would reduce spending and consumption:
Furthermore, among those who were under high repayment stress, 23% said they were considering selling their property.
The analysts found these findings “concerning”, with $640 billion worth of interest-only mortgages outstanding in Australia.
“While these loans are well secured, we believe many borrowers may face substantial stress as interest rates rise or when they revert to principal & interest,” UBS said.
In addition, the analysts expect Australia’s housing market to continue to feel a “lagged impact” from the macro-prudential measures introduced in April.
Those measures put a restriction on new interest-only lending to 30% of all new loans.
And while new loan issuance makes up a relatively small percentage of total credit, UBS said the direction of loan growth is a key driver of the direction of house prices:
“Hence, even a marginal change in credit conditions – such as a drop-off in IO loans – can have a material impact on house price growth,” they said.
In view of that, UBS said the continued impact from macro-pru will have a “large and broader implication for the economy”, combined with other trends such as a switch into principal & interest mortgage repayments.
The broader economic implications are that UBS expects the RBA to keep interest rates on hold until the second half of next year.