Why mortgage stress could be worse than the RBA thinks
The Deputy Governor of the Reserve Bank of Australia (RBA), Michele Bullock, last week offered a cheerful, if not upbeat, interpretation of the circumstances faced by Australian mortgage holders, who are facing the brunt of the RBA’s interest rate rises. For Bullock, and presumably for the RBA, there’s no need to stress. I hope she’s right, but I fear things could get very difficult for a lot of borrowers.
‘Keep calm and carry on, nothing to see here’ appears to be the RBA’s mantra as official rate rises potentially take variable mortgage rates to near seven per cent by this time next year.
According to the RBA’s Bullock, most mortgagees have substantial buffers of savings and have been making repayments ahead of requirements. Most property buyers have also amassed significant equity thanks to the house price growth hitherto experienced. And finally, the most indebted are wealthier and able to service debt.
Quoting Bullock, “…households are in a fairly good position”. Referring to the broader pool of borrowers, “The sector as a whole has large liquidity buffers, most households have substantial equity in their housing assets, and lending standards in recent years have been more prudent and have built in larger buffers for interest rate increases.” The large buffers, according to Bullock come from “many borrowers [are] already making repayments well above what is required.”
Substantial equity comes from prices rising. If prices reverse, however, one plank in the RBA’s view of the world collapses. And making payments above what is required is aided in no small part by ultra-low interest rates and low inflation. Raise interest rates and take more money out of borrowers’ wallets, through rapid increases in the price of fuel, food and utilities, and suddenly payments made ahead of requirements halt.
Bullock again, using “data on individual anonymized loans from our securitization database to do some scenario analysis on the potential impact of interest rate rises on the borrowers in the dataset”, and assuming variable mortgage rates rise by around 300 basis points, “which is broadly informed by recent market pricing to mid-2023” the “data suggest that over one-third of variable-rate borrowers have already been making average monthly loan payments (including irregular payments to redraw and offset accounts) sufficient to meet the resulting rise in required repayments.”
But, Bullock noted, “just under 30 per cent would face relatively large repayment increases of more than 40 per cent of their current payments.”
Bullock also observed the large cohort of borrowers who took out fixed rate mortgages when rates were circa two per cent fixed for four years, will be facing variable rates when the bulk of those loans “roll off”. If variable rates at that time are those currently informed by market expectations, then half of fixed-rate loans by number would face an increase in repayments of at least 40 per cent. “These scenarios suggest large increases in debt servicing for many of those with expiring fixed-rate loans,” added Bullock.
Unfortunately, the RBA does not have visibility of the savings of those with fixed rate mortgages and many are contractually prohibited from making additional repayments to fixed rate loans. The RBA however put its hope in a benign outcome on very low interest payments and the widely noted increase in household savings.
In her concluding remarks, Bullock noted, “On balance, though, I would conclude that as a whole households are in a fairly good position. The sector as a whole has large liquidity buffers, most households have substantial equity in their housing assets, and lending standards in recent years have been more prudent and have built large buffers for interest rates increases. Much of this debt is held by high-income households that have the ability to service their debt and many borrowers are already making repayments well above what is required. Furthermore, those on very low fixed-rate loans have some time to prepare themselves for higher interest rates.”
One thing I know is that usually those with the savings aren’t those with the mortgages. Further, suggesting people on fixed rate mortgages have time to prepare is a slap in the face to those who borrowed believing the RBA’s previous promises rates would remain ultra-low indefinitely.
Property prices are in fact easing, if not falling, in foreign markets where central banks are further along the path of raising rates. And where prices haven’t declined precipitously, turnover has. Getting out at hitherto record prices is all but impossible. And presumably the Australian property market doesn’t possess any magic sauce rendering it immune to the higher cost of borrowing, weaker demand and constrained access to credit.
Property prices are determined by the marginal buyer and seller. It isn’t you or me that determines property prices. We aren’t selling. It’s the couple at next Saturday’s auction, who can no longer meet their mortgage obligations, that will determine the price of property for everyone else. And it’s the (fewer) buyers factoring in higher borrowing costs, the need for a larger deposit, and consequently, a smaller budget who will determine property prices for everyone else.
And finally, while “data suggest that over one-third of variable-rate borrowers have already been making average monthly loan payments sufficient to meet the resulting rise in required repayments”, it means almost two-thirds haven’t been making payments sufficient to meet the resulting rise in required repayments.
It may pay property buyers to keep their powder dry because prices are likely to decline further before this cycle is over.
Let’s hope a recession stops the RBA from doubling short term rates. Oh…wait…that’s not good either.