The Reserve Bank of Australia (RBA) has acknowledged that its rapid interest rate hikes could see some households with mortgages falling into arrears, forcing some to sell their homes or to enter foreclosure.
Key points:
- The RBA says most households should be able to weather its interest rate hikes
- However, some households may be forced to sell their homes or enter foreclosure
- If rates rise by another 1 percentage point, more than half of variable-rate owner-occupiers may see their disposable income fall by in excess of 20 per cent
It says in recent months most indebted households have experienced a decline in spare cashflow and, over the next couple of years, a notable number of owner-occupiers with variable-rate loans could see their spare cashflow turn negative.
The RBA says that, if labour and housing market conditions deteriorate further than assumed, a larger share of households would be expected to fall into arrears on their mortgages.
However, it says, at this stage, it thinks the share of households at high risk of falling into arrears will remain low in the coming years, although the risks for some "vulnerable indebted households" are increasing as interest rates rise.
The news comes after RBA governor Philip Lowe this week said he planned to keep lifting interest rates over the coming months, albeit at a slower pace.
This week, the RBA lifted rates for the sixth month in a row — in what has been the fastest rate-hiking cycle since 1994 — to try to squeeze high inflation out of Australia's economy.
The nation's consumer price index (CPI) measure of inflation is currently 6.1 per cent, which is the highest it has been since the early 1990s.
Threat of foreclosure for some households
The RBA's analysis of the pressures facing households with mortgages can be found in its latest Financial Stability Review (FSR), released on Friday.
Released every six months, the review provides a snapshot of the health of Australia's financial system. It discusses if any financially systemic stresses have recently emerged from local or global economic events.
The previous edition of the FSR was released in April, before the RBA began lifting interest rates in May.
In this latest edition, the RBA says its rapid rate hikes, and higher inflation, have increased the loan payments and living expenses for Australia's indebted households.
It says there is "uncertainty" about how those households will respond to this pressure on their budgets.
However, it acknowledges some households could be forced into foreclosure.
"Although most households are likely to be able to weather increased pressure on their finances for some time, many will need to curtail their consumption and some could, ultimately, see their savings buffers exhausted," the report says.
"If these households have limited ability to make other adjustments to their financial situation — e.g., by increasing their hours worked — and pressure on their finances continues, they could fall into arrears on their loan obligations. Some may eventually need to sell their homes or may even enter into foreclosure," it warns.
The Bank says that, when trying to forecast possible futures, its central scenario for employment and income growth suggests that the share of households at high risk of falling into arrears is expected to remain low over the coming years, which limits direct risks to the stability of the financial system.
However, it says, it is monitoring things closely because risks were increasing for some vulnerable indebted households.
Decline in disposable income of owner-occupiers with variable-rate loans
The RBA has also run a sensitivity analysis to gauge the potential impact that every interest rate rise it has delivered so far — 2.5 percentage points between May and October — could be having on the cashflows of indebted households.
It considered eight different hypothetical households.
In one example, a household earning $150,000 of gross income (around the median income for a couple family with dependent children) with $800,000 in debt, may have seen their monthly spare cashflow (relative to April 2022) decline by around $1,300 — or 13 per cent of their household's disposable income.
According to the analysis, 80 per cent of the overall reduction in the spare cashflow for that hypothetical household would be due to the impact of rising interest rates on their mortgage payments, with inflation playing a much smaller role.
You can see that household in the graph below.
It has an $800,000 debt, and $150,000 gross income. Its disposable income has declined by 13 per cent since April.
The RBA says that, for a household with the same income, $150,000, but with $600,000 in debt (which is around the average loan size for owner-occupiers), the net decline in spare cashflow since April would be 10 per cent of disposable income.
"Households that have borrowed more recently, tend to have larger debts than earlier cohorts and, so, are likely to be more affected than other borrowers," the RBA says.
"For a given amount of debt, households with lower incomes than these hypothetical borrowers would also likely be more affected."
What about more rate increases?
The RBA has also run a sensitivity analysis to see what could happen to the disposable income of indebted households if it lifted the cash rate target by another 1 percentage point from here, with that rate increase fully passed through to variable-rate loan payments.
Under this scenario, which is subject to uncertainty:
- Just over half of variable-rate, owner-occupier borrowers would see their spare cashflows decline by more than 20 per cent over the next couple of years, including around 15 per cent of households whose spare cashflows would become negative
- Another 40 per cent of variable-rate, owner-occupier borrowers would face a more moderate decrease in their monthly spare cashflows of less than 20 per cent from their April-2022 levels, but would be able to accommodate this
- The remainder of variable-rate, owner-occupier borrowers (around 5 per cent) would experience an increase in their cashflows. This group are typically high-income borrowers who spend a low share of their income on essential living expenses and have very low levels of debt, such that the dollar value of their expected income growth would exceed that of their (loan and living) expenses.
Conditions are still manageable, with a caveat
However, overall, the RBA said the majority of owner-occupiers with variable-rate loans still appeared "well placed" to adjust to rising expenses over the next couple of years.
It said they could do that by reducing their non-essential spending, lowering their saving rates, or by gradually drawing down on their pre-payment buffers.
It said higher interest rates and inflation would slow household consumption across the economy, and the pace of economic growth more broadly, but the direct financial stability risks posed by vulnerable borrowers still appeared modest at this stage.
However, it also said, a large increase in unemployment — combined with a historically large decline in housing prices — would pose "a more material risk to loan arrears and defaults."
In July, RBA deputy governor Michelle Bullock said the majority of fixed-rate home loans in Australia were due to expire over the next two years, with the greatest concentration of loans expiring in the second half of 2023.
She said that, when they expired and people rolled onto variable-rate mortgages, the interest rate shock could be noticeable.
"Assuming all fixed-rate loans roll onto variable mortgage rates and new variable rates are broadly informed by current market pricing, estimates suggest that around half of fixed-rate loans would face an increase in repayments of at least 40 per cent," she said at the time.