Up to 30% of mortgage holders could struggle to keep up with their home repayments if interest rates were to increase by 3 percentage points, according to the Reserve Bank of Australia, which says first-home owners, late entrants to the market and low-income loan holders are most at risk.
With the bulk of low fixed-rate loans due to expire in the next two years, about half of those coming into the new variable market will face increases in their repayments of at least 40%. For those whose fixed loans expire in the middle of next year, the reserve bank estimates a median increase of about $650 a month in repayments, or a 45% increase.
By and large, the RBA believes Australia’s mortgage holders – who make up about one-third of homeowners – are “well placed” to absorb the impacts of rising interest rates.
But that’s in the aggregate. It’s those on the margins who will suffer. The bank’s deputy governor, Michele Bullock, told an Economic Society of Australia Brisbane business lunch on Tuesday the impact would not be uniform.
“While in aggregate it seems unlikely that there will be substantial financial stability risks arising from the household sector, risks are a little elevated,” she said.
“Some households will find interest rate rises impacting their debt-servicing burden and cashflow. While the current strong growth in employment means that people will have jobs to service their mortgages, the way the risks play out will be influenced by the future path of employment growth.
“This, along with the Board’s assessment of the outlook for inflation, will be important considerations in deciding the size and timing of future interest rate increases.”
To draw its conclusions, the RBA analysed data from individual anonymised loans on its securitisation database. It conservatively estimated interest rates increasing by 300 basis points, and then examined how many loan holders – based on debt-to-loan ratios, the value of their property compared to the loan and their repayment history – could meet the rate increase.
Part of the reason the bank is optimistic the majority of loan holders will be able to absorb the increases is because of the level of household savings, which increased during the pandemic. The sharp rise in property prices has also given most home loan holders an equity buffer.
But for some, that too is in doubt. The bank estimates that if house prices fall by 20% as a result of the interest rate rises cooling the market, then the number of people with negative equity loans – where the home loan is higher than the value of the asset – will increase from 0.1% to 2.5%.
That’s below the peak of 3.25% in 2019, but if other economic conditions falter – such as wages or employment, the impact could bite harder.
Almost three-quarters of Australia’s household debt is held by borrowers in the top 40% of income distribution. Those in the bottom 20% of incomes hold less than 5% of the debt.
That boosted Bullock’s belief that “a large number of households are likely to be able to handle somewhat higher interest rates”.
“Higher income households can typically devote a higher share of their incomes to debt servicing because their other living expenses tend to account for a smaller share of their income,” she said.
But she warned “highly indebted households are especially vulnerable in the event of a loss of real income through higher inflation, particularly if combined with rising interest rates, and a decrease in housing prices”.
That makes recent borrowers more vulnerable than those who bought into the market earlier, as their debt to income ratio is much higher, and their time with lower interest rates much shorter. They have also had less time for their property to accumulate equity as a buffer. The previous government’s housing market policies mean first-home owners are highly represented in this cohort and, given the higher loan-to-(home)-valuation ratio, they are historically “more vulnerable to a given house price or cashflow shock”.
The RBA would be watching how the loan increases play out, along with any other economic shocks, such as higher unemployment as it considers future interest rate hikes, Bullock said.
