Increases in interest rates since May, combined with higher living expenses, have reduced the spare cash flow of households with average incomes and debts by around 10 per cent, and if rate rises continue through next year the reduction in spare cash flow will double.
The Reserve Bank said that, based on its central scenario for employment and income growth, the share of households at high risk of falling into arrears is expected to remain low over the coming years, limiting direct risks to the stability of the financial system.
However, around 15 per cent of households with mortgage debt would see their cash flow “turn negative”.
The most vulnerable borrowers are recent home buyers, who have had less time to accumulate liquidity and equity buffers, and highly indebted borrowers, who are more sensitive to increases in rates.
The RBA estimated that around 1 per cent of all variable-rate owner occupier loans had a loan-to-income ratio greater than six times and prepayment buffers of less than one months’ payments.
In its latest Financial Stability Review, the RBA looked at the prospects of households with owner occupier variable-rate loans. It said that for a household earning A$150,000 of gross income (around the median for a couple with dependent children) and with debt of $600,000 (around the average loan size for owner occupiers), the net effect of 250 bps of increased interest rates and living expenses increasing in line with inflation over the six months to September has been a decline in spare cash flow of 10 per cent of disposable income.
If interest rates rise by another 100 basis points by the end of 2023, in line with market expectations, just over half would see their spare cash flows decline by more than 20 per cent, including around 15 per cent whose cash flow would turn negative.
On the positive side, the RBA said indebted households have continued to add to their liquidity buffers in recent months, despite the rise in minimum loan repayments.
Balances in offset and redraw accounts have increased by around $110 billion, or 7 per cent of household disposable income, since March 2020. Around 35 per cent of borrowers have prepayment buffers equivalent to more than two years’ worth of their minimum payments.
Around 40 per cent of borrowers have buffers of less than three months’ payments.
If interest rates were to increase broadly in line with market expectations out to the end of 2023, aggregate scheduled principal and interest payments are projected to rise to a level that is roughly on par with the total payments households were making, including excess payments into offset and redraw accounts, prior to the commencement of the tightening cycle.
Assuming that all the cash rate increases so far have been passed through to borrowers, around 40 per cent of variable rate borrowers would not have to increase the payments at all, if their excess payments are factored in. A further 15 per cent would experience an increase of 20 per cent in monthly payments.
Around 20 per cent will have their minimum