How many Australians are now likely to have trouble with their mortgages?
The sharp rise in mortgage rates over the past few months will force families to make complex changes to how they spend their money.
What is mortgage stress?
There is no official definition of mortgage stress, but it is when a family has trouble making home loan payments. People who spend more than 30% of their income on mortgage payments are often used as a measure. However, it doesn’t do an excellent job of expressing this idea.
Situations are different for everyone. This is usually easy for households with more money, but it can be challenging for families with less money. Homes that choose to pay more than this amount should not be considered to be under mortgage stress.
Even though there is no good way to measure all mortgage stress, there is a narrower way: borrowers who are behind on their mortgage payments.
The government keeps track of 90 days or more loans behind on payments. This is called a “non-performing loan.”
It’s hard to make direct comparisons, but if you look at history or other countries, the number of people behind on their mortgages is very low.
The number of mortgages 30–89 days behind on their payments has also gone down.
There is an apparent reason why mortgage stress is low right now. Most stress comes from a loss of income, like when someone loses their job, gets sick, or breaks up with someone.
Since the current unemployment rate is the lowest in almost 50 years, most households can still pay their mortgages even though other costs are rising.
That could change, in any case.
Will higher rates push more households into mortgage stress?
Mortgage costs are going up quickly. Since the most recent increase in September is taken into account, they have gone up by about a third since May.
Since 1994, this is the fastest the Reserve Bank has raised interest rates, and more increases are likely.
This is in addition to the fact that consumer prices have increased by 6% in the past year.
Most people who take out loans can handle these budgetary pressures. Even though they are not in danger, many people will find it hard to make the necessary changes to their spending.
Most borrowers can handle these extra costs because lenders look at their ability to pay back loans at a rate three percentage points higher than the loan rate, or at least around 5.25 percent.
This makes it clear that borrowers can handle an increase in interest rates, and we haven’t seen increases above this level yet (interest rates increased 2.25 percentage points from May to September 2022).
But interest rates will go up even more—the markets expect another 1.5 percentage points—which will make them higher than what recent borrowers have been judged on.
Even then, the only people who might be in a stressful situation are those who have borrowed close to their limit since other people, by definition, have extra money they can use to pay back more.
Few people borrow as much as they can. Commonwealth Bank, the largest lender, thinks that about 8% do.
How many borrowers might be pushed into mortgage stress?
An extreme scenario will be if interest rate rises push all recent borrowers close to their borrowing limits and can no longer afford mortgage repayments.
Since March 2020, more than 1.1 million new loans have been taken out to purchase new or existing properties – 8% of these are around 92,000.
This is an unlikely scenario because households can generally make significant adjustments to spending to afford their mortgage, at least while employment prospects are good.
While extremely unlikely, in this scenario, the rate of non-performing loans would reach around 5.5%. That is high but not unprecedented.
While this would be much higher than levels seen during the 90s recession in Australia, it is well below the stories in the US after the Global Financial Crisis, which reached more than 10%.
Housing price gains may mean stress won’t show in official data
Even in this worst-case scenario, most borrowers who have trouble making higher mortgage payments won’t end up on the government’s records.
Borrowers can ask for times when their payments are lower to get back on track, or if all else fails, they can sell their property to pay off the loan.
These families are having trouble paying their bills. But one problem with data on loans that aren’t being paid back is that they won’t always be recorded.
The stress measures usually need two shocks to happen simultaneously: a significant change in income or expenses that make it impossible for borrowers to make payments and a drop in home prices that makes it impossible to sell the house to pay off the loan.
Almost everyone can sell their home right now to pay off their mortgage. RBA data shows that less than 0.25% of loans are in “negative equity,” meaning that the loan is more significant than the property’s value.
If home prices keep going down, that will change a little bit.
A 15% drop from the peak would bring prices back to where they were in March 2021. So only people who bought a home after that point would be at risk of going into negative equity, and only if prices fell more than their deposit, which is almost always 20% or more. Only about 6.5% of people who want to borrow money start with a deposit of 10% or less.
Mortgage stress is unlikely to rise markedly
Even though it’s unlikely that mortgage stress will get much worse, stressful things could happen.
When people are forced to sell their homes, much stress is involved. But it’s not clear how many homes will be in this situation. It will depend on how fast interest rates go up and how well the job market does.
When people who are having trouble making payments sell their homes, it could cause prices to drop even more and push other people into negative equity. The Australian Prudential Regulation Authority and the RBA will closely monitor these “systemic” worries.
Higher interest rates and inflation will cause all borrowers to change how much they spend. This is done on purpose. The RBA is raising interest rates to reduce demand in the economy, and one of the main ways they can do this is by putting more money in the pockets of borrowers.
Even though there probably won’t be much stress, many households may have a hard time financially in the coming months.
“Impaired” loans are also non-performing because they are unlikely to be paid back, and the property’s value no longer covers the loan.
Before October of last year, the buffer for the interest rate was 2.5 percentage points.
But loan evaluations haven’t considered the high inflation rates, which could lead to more stress than expected, given the rise in interest rates.
