Rates are on the rise and people are worried about the housing market.
Borrowers are being squeezed by one of the fastest rate hiking cycles in a generation. The cash rate was 0.1% in April, 1.35% today and markets expect it to reach 3.4% come December. Deputy Governor Michelle Bullock spoke in Brisbane on Tuesday about how households will handle the upcoming jump in mortgage repayments. It was the first time the RBA has weighed in on the matter in detail since the bi-annual Financial Stability Review was published in April.
Here’s what we learnt.
Two ticking bombs in the housing market
Bullock delivered tough news for mortgage payers on Tuesday, with both variable and fixed rate borrowers in for massive repayment shocks over the next twelve months.
In her speech, Bullock presented the results of an RBA modelling exercise looking at how mortgage owners would fare should rates rise by 3% over the next year.
The model estimates that just under a third of variable-rate borrowers would see repayments soar by 40% or more.
Homeowners are already facing a sharp increase in mortgage repayments. The average variables across the big four was 2.57% one year ago, according to RateCity. Today it’s 3.29%, up a 72% increase.
Those who took advantage of low interest rates to lock in fixed-rate mortgages since the pandemic are also in for a repayment scare.
Under the assumption that all fixed-rate loans roll onto variable mortgage rates, the RBA estimates around half of fixed-rate loans will see repayments rise at least 40%.
A $650 increase in monthly repayments awaits the median borrower for fixed-rate loans expiring at the end of 2023.
Overly rosy future
The RBA’s scenario analysis assumed no change unemployment, a dangerous assumption, says AMP Chief economist Shane Oliver.
“The analysis doesn’t allow for a change in employment circumstances,” he says. “[The report] sort of says that on average it will be ok but if people lose their job and the economy goes into recession it’s a different story.”
“Interest rate hikes aren’t occurring in isolation; they’re occurring at a time when there has been a significant increase in cost of living and wages haven’t kept up,” he added.
The assumption that unemployment remains at record level lows comes amid bubbling global recession concerns boiling over into already bearish equity markets.
Watch out first time home buyers
Bullock called out recent first home buyers along with highly indebted households and fresh borrowers as more vulnerable because these groups tend to have less savings built up.
“Historically, first home buyers have tended to have persistently higher loan to valuation and lower liquidity buffers than other borrowers, making them more vulnerable to a given house price or cash flow shock,” said the deputy governor.
But the RBA is not worried
Despite the issues, Bullock highlighted several reasons why the housing market should remain stable as the cash rate rises: big equity buffers thanks to years of house price appreciation and large pools of savings.
Australian homeowners have enjoyed decades of record price growth, with a big surge over the pandemic period. That’s left many homeowners sitting on lots of equity that could buffer against a dip in house prices.
Then there’s the $260 billion dollar households put away during the pandemic thanks to government support and restricted spending opportunities. Bullock says this should help cushion the jump in mortgage repayments.
“The household saving rate rose sharply [during the pandemic] and many households therefore built-up large liquidity buffers, including those households with mortgages,” said Bullock.
The RBA model showed that one third of variable rate borrowers will experience no change in repayments because their average monthly repayments already meet the amount required should rates rise 3%.
Most of the debt is held by the wealthy
One reason for the bank’s optimism is that many of the biggest and most-at-risk borrowers are high income households, said Bullock.
More than three-quarters of Australia’s mortgage debt is held by households in the top 40% of the income distribution. Wealthier Australians are also more likely to be among those with the highest debt-to-income ratios.
“Higher income households can typically devote a higher share of their incomes to debt servicing because their other living expenses tend to account for a smaller share of their income,” she said.