The Reserve Bank of Australia (RBA) has acknowledged that its rapid interest rate hikes could see some households with mortgages fall into default, forcing some to sell their homes or enter foreclosure.
- The RBA says most households should be able to withstand its interest rate hikes
- However, some households may be forced to sell their home or foreclose
- If rates increase by another percentage point, more than half of variable rate homeowners could see their disposable income drop by more than 20%.
It says that in recent months most indebted households have seen their free cash flow decline, and over the next couple of years a notable number of homeowners with variable rate loans could see their free cash flow turn negative.
The RBA says that if labor and housing market conditions deteriorate further than expected, a greater proportion of households are expected to be in arrears on their mortgages.
However, he says that at this stage he thinks the share of households at high risk of being in arrears will remain low in coming years, although the risks for some “vulnerable indebted households” increase as interest rates rise.
The news comes after RBA Governor Philip Lowe said this week that he plans to continue raising interest rates over the coming months, albeit at a slower pace.
This week, the RBA raised rates for the sixth consecutive month – in what was the fastest rate hike cycle since 1994 – in an attempt to stamp out high inflation from the Australian economy.
The country’s consumer price index (CPI) inflation measure is currently at 6.1%, which is the highest since the early 1990s.
Threat of seizure 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 Friday.
Published every six months, the review provides an overview of the health of Australia’s financial system. It examines whether financial systemic stresses have recently emerged from local or global economic events.
The previous edition of the FSR was published in April, before the RBA started raising interest rates in May.
In this latest edition, the RBA says its rapid rate hikes and rising inflation have increased loan repayments and living expenses for indebted Australian households.
He says there is “uncertainty” about how these households will react to this pressure on their budgets.
However, he acknowledges that some households could be forced into foreclosure.
“Although most households are likely to face increased pressure on their finances for some time, many will need to reduce consumption and some may eventually see their savings reserves depleted,” the report said.
“If these households have a limited ability to make other adjustments to their financial situation – for example, increasing their hours worked – and the strain on their finances continues, they could fall behind on their loan obligations. may eventually have to sell their home or may even go into foreclosure,” he warns.
The Bank indicates 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 incurring arrears is likely to remain low over the next few years, which which limits direct risks to the stability of the financial system.
However, he said, he is watching things closely as the risks were increasing for some vulnerable indebted households.
Lower disposable income for homeowners with variable rate loans
The RBA has also carried out sensitivity analysis to assess the potential impact that each interest rate hike it has provided so far – 2.5 percentage points between May and October – could have on cash flows. cash flow of indebted households.
He considered eight different hypothetical households.
In one example, a household earning $150,000 in gross income (approximately the median income of a couple family with dependent children) with $800,000 in debt, may have seen their monthly free cash flow (compared to April 2022) decrease. of about $1,300 – or 13 percent of their household’s disposable income.
According to the analysis, 80% of the overall reduction in excess cash for this 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 this household in the graph below.
He has a debt of $800,000 and a gross income of $150,000. His disposable income has fallen 13% since April.
The RBA says that, for a household with the same income, $150,000, but with debt of $600,000 (which is the average loan size for homeowners), the net decline in excess cash since April would be 10% of disposable income. .
“Households that have borrowed more recently tend to have larger debts than previous cohorts and, therefore, 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 further rate increases?
The RBA also carried out a sensitivity analysis to see what might happen to the disposable income of indebted households if it raised the cash rate target by another percentage point from here, with that rate increase being entirely passed on to variable rate loan repayments.
In this scenario, which is subject to uncertainty:
- Just over half of variable rate homeowner borrowers would see their available cash decline by more than 20% over the next two years, including about 15% of households whose available cash would turn negative.
- Another 40% of variable rate homeowner borrowers would face a more moderate decrease in their monthly idle cash flow of less than 20% from their April 2022 levels, but would be able to adjust to that.
- The rest of the variable rate homeowner borrowers (about 5%) would experience an increase in their cash flow. This group is typically made up of high-income borrowers who spend a small portion 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 expenses (loans and subsistence).
Conditions are still manageable, with a caveat
Overall, however, the RBA said the majority of homeowners with variable rate loans still appeared “well positioned” to adjust to rising spending over the next two years.
He said they could do this by cutting back on non-essential spending, lowering their savings rate or gradually dipping into their prepayment reserves.
He said higher interest rates and inflation would slow household consumption across the economy and the pace of economic growth in general, but the direct risks to financial stability posed by vulnerable borrowers still seemed modest at this point.
However, he also said a sharp rise in unemployment – combined with a historically large fall in house prices – would pose “a greater risk for 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 within 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 switched to variable rate mortgages, the interest rate shock could be noticeable.
“Assuming all fixed rate loans move to variable mortgage rates and new variable rates are largely informed by current market prices, estimates suggest that around half of fixed rate loans would face an increase. refunds of at least 40%”, she said at the time.
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