One in four borrowers could fall into mortgage stress next year

Rising interest rates make first-home buyers, low-income families especially vulnerable, RBA says

One in four borrowers could fall into mortgage stress next year

One in four homeowners with a variable-rate mortgage would be pushed into mortgage stress if the cash rate rises by another full percentage point, according to new data from the Reserve Bank.

In its latest Financial Stability Review, published Friday, the RBA said that rising interest rates and cost-of-living woes made first-home buyers, low-income families and overstretched borrowers especially vulnerable to loan default.

The RBA also said global financial instability was on the rise amid plummeting asset prices, market volatility and geopolitical tensions. International Monetary Fund managing director Kristalina Georgieva said that the global economy could lose US$4 trillion in output by 2026, The Australian reported.

The RBA’s report said the broader Australian financial system was still strong due to high profitability, robust capital levels and strong liquidity. However, the central bank said that some families would have to cut discretionary spending and raid their savings to cover ballooning mortgage costs.

Treasurer Jim Chalmers said Friday that the central bank’s six consecutive rate hikes “were having an impact on the finances of ordinary Australians”.

“The higher interest rates go, the more they will sting ordinary Australians,” Chalmers said. “Some Australians have a buffer in their personal finances, but many don’t.”

With the unemployment rate pegged to rise from a near 50-year low of 3.5% as the economy slows, negative equity in homes, business failures and bad debts could become more common, The Australian reported.

“Higher interest rates and inflation will slow aggregate household consumption and the pace of economic growth more broadly, but the direct financial stability risks posed by vulnerable borrowers appears more modest,” the RBA report 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, and therefore financial stability.”

The central bank said that more insolvencies were likely in the struggling residential construction sector, and although banks have limited exposure to builders, “there is potential for financial stress to spread to other businesses within the broader construction industry and to some households.”

Last week, the RBA raised the cash rate target by 0.25 percentage points to 2.6%. RBA Governor Philip Lowe said in a statement that the central bank “expects to increase interest rates further over the period ahead”.

The RBA’s report found that if interest rates were to rise by a cumulative 3.5 percentage points – which is largely in line with market expectations to the end of 2023 – and incomes rose in line with predicted wage growth, the share of borrowers facing a minimum debt-servicing ratio greater than 30 would rise to around 25% by the end of next year, The Australian reported. Those with loan repayments of more than 30% of their pre-tax household income are considered to be under mortgage stress.

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If unemployment were higher and income growth fell below expectations, even more families would be under mortgage stress by the end of 2023.

The central bank also noted that many fixed-rate borrowers were looking at changes of three to four percentage points to their mortgage rates when their fixed terms expired. Two-thirds of these fixed-rate loans are due to expire by the end of next year, The Australian reported.

Commonwealth Bank economists said: “exactly how households respond to this cashflow impact is crucial for the economic outlook.”

“While the [RBA] may be broadly content that most households can cope with higher interest rates and that banks are highly liquid, this does not mean that tightening financial conditions will not materially lower household consumption growth and consequently slow the economy in the coming period,” CBA economists Harry Ottley and Kristina Clifton wrote in a research note. “A stable financial system does not guarantee a strong economy.”