RBA reveals the Aussies most at risk of being unable to meet their mortgage repayments

The Reserve Bank of Australia has warned some may find it hard to meet their mortgage payments as interest rates and the cost of living rise further, although most households will be able to cope.

Recent homebuyers and those with low savings and high levels of debt are among a small group of borrowers who could fail to meet debt payments, the RBA noted in its latest Financial Stability Review on Friday.

“A small group of borrowers in Australia are particularly vulnerable to repayment difficulties due to rising interest rates and cost-of-living pressures,” the RBA said.

“Many of these households have low liquidity buffers, low incomes and high debt relative to their income.

“A large decline in housing prices that results in negative equity for households, alongside further shocks to disposable income, would increase the risk that some borrowers default on their loan commitments.”

The report, which focused on financial stability risks in the economy, noted income growth has not kept up with inflation, leaving households with less capacity to service their debts.

“Many households will be able to manage this by reducing their spending and/or their rate of saving. However, a small share of borrowers with lower savings and high debt are vulnerable to payment difficulties.

“As a result, housing loan arrears rates are likely to increase in the period ahead from currently low levels.

“Debt-servicing challenges will become more widespread if economic conditions, particularly the level of unemployment, turn out to be worse than expected and housing prices fall sharply.”

The RBA noted there have been limited signs of a pick-up in financial stress across households to date.

But it said some are already facing more challenging conditions and the combination of higher interest rates and inflation will further increase pressure on household budgets.

“Overall, most borrowers are likely to be well placed to adjust their finances, with only a small share appearing vulnerable to falling into arrears.”

The RBA on Tuesday raised the cash rate for the sixth month in a row, but slowed the pace to a “business as usual” 25 basis point increase after four consecutive double hikes.

The RBA has now hiked rates by 250 basis points since May, taking the cash rate to 2.6% – the highest level since 2013. More rate hikes are expected as it tries to bring inflation back down.

The borrowers who are most vulnerable

The RBA pinpointed recent first-home buyers and borrowers on low incomes who have small financial buffers and high debt as being most vulnerable to repayment difficulties as rates and the cost of living rise.

It said the most vulnerable borrowers are those who are both highly indebted and have low prepayment buffers, adding that these people make up only a small share of indebted households.

RBA analysis indicated the majority of owner occupiers with variable-rate loans have the ability to adjust to a period of higher interest rates and inflation, partly due to substantial savings buffers built up during the pandemic.

But the RBA said a small share of these borrowers “are vulnerable to debt-servicing difficulties and, ultimately, default”.

“A small group of variable-rate borrowers with low incomes, small liquidity buffers and high debt are most vulnerable to payment difficulties – including those with relatively new loans and less housing equity.

“Fixed-rate borrowers will also face large increases in their minimum loan payments when their fixed terms expire.

“As such, housing loan arrears rates are likely to increase from low levels in the period ahead.”

The Financial Stability Review said recent homebuyers are more vulnerable to debt-servicing challenges and default in a rising interest rate environment, as they have had less time to accumulate liquidity and equity buffers.

RBA data showed that as of August, around half of all homebuyers who took out loans since the start of 2021 had prepayment buffers equivalent to less than three months of their scheduled repayments. That compared to less than 40% of total borrowers.

“Recent homebuyers – and in particular first-home buyers (FHBs) – are also over-represented among borrowers with low equity buffers,” the RBA said, adding that cohort had a higher share of loans with current loan-to-valuation ratios greater than 80%.

The RBA said highly-indebted borrowers are more vulnerable than others because their interest expenses are more sensitive to increases in interest rates, adding home owners who borrowed in the past two years are more likely to be highly indebted.

Recent first-home buyers would also be more exposed to a sizeable fall in housing prices than other borrowers, the RBA said.

“Newer loans, including those taken out by FHBs, are more likely to experience negative equity not only because borrowers tend to start with higher LVRs than repeat buyers and investors but also because they have had less time to accumulate excess payments and to benefit from housing price growth.

“Recent FHBs are also more likely to experience financial stress.”

But the RBA noted there is no systemic risk to banks as these loans account for less than 10% of outstanding loan balances.

“Consistent with this, even very large future housing price declines would only result in a small share of all loans entering negative equity, although an environment in which there were a large number of forced sales could further amplify the price cycle.”

While many economists predict a top-to-bottom fall in home prices of 15% to 20% into next year, prices will still be above pre-pandemic levels.

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