First home buyers, many of them clustered in the outer suburbs of Australian cities, are most likely to struggle under what could prove to be an onslaught of interest rate rises, analysts say.
The Reserve Bank again surprised the market on Tuesday, lifting its official cash rate by 50 basis points to 0.85% and signalling more increases to come. The “shock and awe” rise – as one economist dubbed it – was the largest since February 2000.
Governor Philip Lowe said “one source of uncertainty” for the RBA was how household spending, a key engine of the economy, would weather mounting pressure as the prices of most things increase. That burden now includes bigger debt repayments.
Lowe noted that while house prices had lately dropped in some markets, they were still about one quarter higher than pre-pandemic. Savings-to-income ratios, while in retreat, were also higher than pre-Covid times. Hence, many “households have built up large financial buffers” that would help them absorb extra borrowing costs.
However, that calculus, while broadly true, overlooks the reality that average asset values and bank savings sizes aren’t much consolation for those already under financial stress. How these people fare could have wider consequences for society, economic growth and even banks’ bad debts as the pain of ballooning debt repayments will likely fall disproportionately, economists said.
“We’ve had just over 400,00 first time buyers in the last three years,” said Hal Pawson, a professor of housing at UNSW. “Almost all of them will have probably borrowed pretty much the maximum amount that they felt they could afford … It’s that group that we really should be concerned about.”
Pawson was involved in research last year that found the most financially at-risk households were typically found in outer suburbs around Australia. They were lured by cheaper land, but also government incentives favouring new homes over flats.
Many budgets are already starting to be strained by higher food costs, with soaring energy and fuel bills making it harder for households to cope.
Fuel bills were “another factor that has changed [in the past six months] and that unfortunately is only going to compound the situation for a lot of first home buyers”, Pawson said, adding outer suburbs residents often have to drive further than most commuters to get to work.
Cherelle Murphy, EY’s chief economist, said the RBA was willing to accept that “some households will struggle” as rates rise but it had few options to limit inflation.
“It only has one blunt tool, which unfortunately means some households will see most of their discretionary income eaten up by recent economic developments,” Murphy said. “While it’s of little comfort to some households, the current level of interest rates, even at the increased level of 85 basis points, is extraordinarily low.”
“[Borrowers] should expect more hikes in their mortgage rates, and perhaps even additional basis points from the banks who may try to claw back some margin as the cycle progresses,” she said.
Prior to Tuesday’s rate rise, investors were expecting the cash rate to rise by another two percentage points by the end of 2022 alone.
Pradeep Philip, head of Deloitte Access Economics, said “the economy is a bit more fragile than people have realised”. Global developments, such as a slowing China and the US, are among the headwinds that could stall growth in Australia.
“There are limits to how monetary policy can deal with structural issues in the economy,” Philip said. The way the burden of higher debt repayments was spread across households “was something we need to pay attention to”.
Home loans for owner-occupiers fell in April by 7.3%, or the most since May 2020 - ahead of the RBA's first rate rise last month. pic.twitter.com/RXOnK6KzEQ
— Peter Hannam (@p_hannam) June 7, 2022
Authorities, including the RBA, say they will monitor how borrowers respond to higher interest rates, but also how banks cope with a possible increase of bad debts.
Wayne Byres, the chair of the Australian Prudential Regulation Authority, told a bank summit on 31 May that housing made up about 60% of banks’ total loans and had been growing gradually over time.
“Historically, housing loan portfolios have been low-risk, and acted as ballast for the industry through turbulent periods,” Byres said. “Housing loans have been, as they say, as safe as houses.”
According to @APRAinfo, housing loans have historically been relatively safe as far as credit losses go. pic.twitter.com/XTck5MF5yR
— Peter Hannam (@p_hannam) June 7, 2022
However, “that may not be the pattern in the future”, he said.
“We are now entering a very different environment than has existed for much of the past decade,” Byres said. “The faster-than-expected emergence of higher inflation and interest rates will have a significant impact on many mortgage borrowers, with pockets of stress likely, particularly if interest rates rise quickly and, as expected, housing prices fall.”
At most risk will be residential mortgage borrowers, who took advantage of very low fixed rates over the past couple of years. These households face a sizeable “repayment shock” when they refinance in the next year or two, possibly compounded by having loans that were larger than the diminished value of their property.
“Interestingly, this [lending] growth has not been an industry-wide development, but rather has been concentrated in just a few banks,” Byres said, suggesting it won’t just be households under the regulators’ microscope.
