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The number of Aussie borrowers now likely to experience mortgage stress

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The sharp rise in mortgage rates in recent months will require households to make difficult spending adjustments.

How many Australians are currently at risk of experiencing mortgage stress?

What is mortgage stress?

There’s no official definition of mortgage stress, but it’s basically when a family struggles to pay their mortgage.

A commonly cited metric is people spending 30% or more of their income on mortgage repayments. But it doesn’t capture this concept well.

Everyone’s situation is different.

Rapidly rising interest rates will put pressure on Australian households.Photo: Getty

While high-income households can easily make such repayments, low-income households may struggle. Households that choose to increase their repayments past this threshold certainly shouldn’t be considered mortgage stress.

There is no good measure that captures all mortgage stress, but a narrower measure is borrowers who are behind on their mortgage payments.

Official data covers non-performing loans, which track loans that are more than 90 days past due.[1]

Although it is difficult to make a direct comparison, the number of people who are behind on their mortgages is now very low compared to the past and other countries.

Also, the proportion of mortgages that are 30 to 89 days past due has decreased.

There are clear reasons for the current low stress levels of mortgages. Most stress is caused by loss of income. Family members lose their jobs, become ill, or have broken relationships.

The current unemployment rate is at its lowest level in almost 50 years, meaning most households can continue to pay their mortgages even if other costs rise.

But that could change.

Will higher interest rates push more households into mortgage stress?

Mortgage costs are rising rapidly, up about a third since May, taking into account the most recent September rise.

It was the Reserve Bank’s fastest rate hike since 1994, and more is expected.

This is compounded by other pressures on the cost of living, such as consumer prices rising 6% over the past year.

Cost of living pressures collide with rising interest rates.Photo: Getty

The vast majority of borrowers can withstand these budgetary pressures. No stress, but the necessary spending adjustments are almost certainly difficult for many.

Most borrowers are well positioned to absorb these additional costs. Lenders rate their repayment ability at 3 percentage points higher than the loan interest rate (at least about 5.25%).[2]

This provides a clear guarantee that borrowers will be able to withstand higher interest rates, which we have yet to see rise above this level (interest rates rose by 2.25% from May to September 2022).[3]

However, rates are expected to rise further and the market expects another 1.5 percentage points to rise, which could push rates above the levels at which recent borrowers are assessed.

Still, only borrowers who borrow close to the maximum amount may experience stress. Because others, of course, have surplus income to make more repayments.

Very few people borrow anywhere near the limit. The largest lender, Commonwealth Bank, puts it at around 8%.

Some borrowers experience mortgage stress.Photo: Getty

How many borrowers could be under mortgage stress?

An extreme scenario is when rising interest rates force all recent borrowers nearing their credit limit to the point of not being able to make their mortgage payments.

Since March 2020, over 1.1 million new loans have been issued to purchase new or existing properties. 8% of these are about 92,000 loans.

This is an unlikely scenario. Households can usually adjust their spending significantly to meet their mortgage payments, at least as long as employment prospects are good.

In this scenario, which is highly unlikely, the NPL rate reaches about 5.5%. It’s expensive, but not unprecedented.

This is much higher than the levels seen during the recession in the 90s in Australia, but much lower than the levels seen in the US after the global financial crisis, which reached more than 10%.

Higher house prices could mean stress doesn’t show up in official data

Even in this extreme scenario, most borrowers struggling to increase their mortgage payments end up not being recorded in official data.

Borrowers can ask for a period of reduced repayments to get back on track. In extreme cases, you can even sell your property to pay off the loan.

These households are clearly experiencing economic stress. However, a limitation of bad debt data is that it is not always recorded.

Interest rates are trending higher.Photo: Getty

The stress it tracks usually requires two simultaneous shocks: a large income or expense shock, meaning the borrower can no longer afford to repay, and selling the property to pay off the loan. It’s a fall in housing prices that can’t be done.

At this point, most people have the option of selling their home and paying off their mortgage. Less than 0.25% of his loans are at “negative equity” (where the loan is greater than the asset value), according to RBA data.

Things would change if house prices continued to fall, but not by much.

A 15% price drop (from the peak) will bring prices back to March 2021 levels. Most of the time it fell more than 20% only when it also fell. Only about 6.5% of borrowers start with a 10% (or less) deposit.

Mortgage stress unlikely to rise significantly

Mortgage stress is unlikely to increase significantly, but it can have stressful consequences.

A forced sale of real estate obviously involves a great deal of stress. However, it is unknown how many households will end up in this situation. That depends on how much interest rates rise and the performance of the labor market.

A sale by a borrower who is struggling to repay can cause home prices to fall, forcing other borrowers into negative assets. These “systemic” concerns will be watched closely by Australia’s prudential regulator and her RBA.

Of course, cost pressures from rising interest rates and inflation mean that all borrowers will have to adjust their spending. This is intentional. The RBA is raising interest rates to reduce demand in the economy, a key channel through which is the waist pockets of borrowers.

While not likely to cause a lot of stress, many households can be going through tough times financially.

[1] Bad debt also includes “impaired” loans whose repayments are questionable and whose asset value no longer covers the loan.

[2] Prior to October last year, the interest rate buffer was 2.5 percentage points.

[3] However, loan valuations do not reflect high inflation. This could mean higher than expected stress for a given rate hike.

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