Recent home loan borrowers and borrowers who will roll out of fixed-rate loans over the next couple of years are the ones causing most concern to the Reserve Bank as it assesses Australian households’ capacity to deal with rising interest rates.
Reserve Bank deputy governor Michele Bullock said the most vulnerable group is recent borrowers, as they are more likely to have borrowed at high debt-to-income ratios, have had their serviceability assessed at lower interest rates and have had less time to accumulate equity and liquidity buffers.
Speaking at an Economic Society of Australia (Qld) event yesterday, Bullock said low fixed-rate loans on offer in 2020 and 2021 resulted in the share of housing credit on fixed rates rising from 20 per cent at the start of 2020 to a peak of nearly 40 per cent in early 2022.
The majority of outstanding fixed-rate loans are due to roll off within the next two years, with the greatest concentration of loans due to mature in the second half of 2023.
Assuming all fixed-rate loans roll into variable mortgage rates and new variable rates are broadly informed by current market pricing, Bullock said RBA estimates suggest that around half of fixed-rate loans would face an increase in repayment of at least 40 per cent – a median increase of around $650 a month.
“We have very little visibility of how much saving those with fixed rates have been doing in recent years,” she said.
More generally, Bullock reiterated the RBA’s view that Australian households are well placed to deal with rising interest rates, citing strong household balance sheets, increases in savings and the accumulation of sizeable home equity through higher house prices.
“Just how high and how fast the cash rate is raised will depend on many factors but in making this assessment one of the areas the board will be closely observing is how households, particularly its indebted homeowners, respond to the combination of rising interest rates and prices,” Bullock said.
The household credit-to-income ratio is currently around 150 per cent. This is high relative to the early 1990s. Most of the run-up through the 1990s and the first half of the 2000s, resulting from lower inflation, financial deregulation, a decline in real interest rates and strong income growth – all of which allowed households to service higher levels of debt.
Since then it has remained relatively steady at a high level.
Bullock said: “The high level of debt held by Australian households might, on its own, suggest that many households will face difficulties as interest rates rise.
“However, there are a number of factors that suggest considerable resilience in the household sector to rising interest rates.”
Household balance sheets are in “very good shape”. Strong growth in house prices over 2021 and early 2022 boosted assets value for many homeowners. The decline in housing prices in recent months has only marginally eroded some of the large increases seen over past years.
Households have saved a large amount of money since the onset of the pandemic – around A$260 billion. This is held in savings, redraw and offset accounts.
Since the start of the pandemic, payments into offset and redraw accounts has been around 3.5 per cent of disposable income.
Bullock said: “If we take these savings into account, the ratio of household credit to income is actually a fair bit lower than the headline figure and is around the same as the 2007 level. The accumulated stock of these savings could help to ease the transition to higher mortgage payments for many borrowers, allowing them to sustain higher levels of consumption than otherwise.”
Around half of households with variable rate owner occupier mortgage debt have enough prepayments to service their current loan repayments for almost two years.
“The strength of lending standards in recent years gives us reason to be confident in the ability of many households to absorb some increase in interest rates,” she said.
On the equity issue, the share of loan balances in negative equity fell from a peak of 3.25 per cent in 2019 to around 0.1 per cent in May this year.
A 10 per cent decline in housing prices would raise the share of loan balances in negative equity to 0.4 per cent. A fall of 20 per cent would increase the share of balances in negative equity to 2.5 per cent.
As to the distribution of debt among households, three-quarters of household debt is held by households in the top 40 per cent of income distribution. Indebted households in the bottom 20 per cent of income distribution hold less than 5 per cent of the debt.
Bullock said borrowers with the most debt tend to have the highest liquidity buffers.