Household Finances – Page 35 – Digital Finance Analytics (DFA) Blog

Brokers have ‘important role to play’ for stressed households

Mortgage brokers have an important role to play for the increasing number of households experiencing mortgage stress, as they are a “very good source of advice” according to a market analyst.

Around 52,000 households are now at risk of default in the next 12 months, according to mortgage stress and default modelling from Digital Finance Analytics for the month of April.

The modelling revealed that across the nation, more than 767,000 households are now in mortgage stress (669,000 in March) with 32,000 of those in ‘severe’ stress. Overall, this equates to 23.4 per cent of households, up from 21.8 per cent on the prior month.

Speaking to Mortgage Business, Digital Finance Analytics principal Martin North remarked that mortgage brokers have a role to play for stressed households in terms of helping them “find their way through the maze”.

“Maybe that’s a restructure, maybe it’s a different type of loan… I think [brokers] are a very good source of advice for households and for people who come and seek guidance [for example] refinancing may help,” Mr North said.

In saying this, Mr North noted that when it comes to identifying an appropriate loan for customers, brokers should remain “conservative” in their estimation of what households can afford.

“Don’t encourage households to borrow as big as they can. That 2 to 3 per cent buffer is really important, and those spending and affordability calculations are really important.

“There’s an obligation both on brokers and on lenders to do due diligence on borrowers to make sure that they’re not buying unsuitably, and that includes detailed analysis of household expenditure.

“My observation is that some of those calculations don’t necessarily get to the real richness of where households are at, so I think that all those operating in the market need to be aware of the fact that how we look at spending becomes really important on mortgage assessments.”

Mr North added that brokers should operate on the assumption that rates and the cost of living will continue to rise, while incomes remain static.

“So, don’t try and flog that bigger mortgage,” he recommended. “I would say be conservative in your advice and the structure of the conversation you have.”

The latest results of Digital Finance Analytics’ mortgage stress and default modelling are “not all that surprising”, Mr North said, considering that incomes are static or falling, mortgage rates are rising, and the cost of living remains “very significant” for many households.

“All those things together mean that we’ve got a bit of a perfect storm in terms of creating a problem for many households,” he said, adding that for many households, any further rises in mortgage rates or the cost of living would be sufficient to move them from ‘mild’ to ‘severe’ stress.

“It doesn’t take much to tip people over the edge. It takes about 18 months to two years between people getting into financial difficulty and ultimately having to refinance or sell their property or do something to alleviate it dramatically, so I think we’re in that transition period at the moment as rates rise… over the next 12 to 18 months my expectation is that we would see mortgage stress and defaults both on the up.”

According to Mr North, Digital Finance Analytics’ data uses a core market model, which combines information from its 52,000 household surveys, public data from the RBA, ABS and APRA, and private data from lenders and aggregators. The data is current to the end of April 2017.

The market analyst examines household cash flow based on real incomes, outgoings and mortgage repayments. Households are “stressed” when income does not cover ongoing costs, rather than identifying a set proportion of income, (such as 30 per cent) directed to a mortgage.

What The Mortgage Stress Data Tells Us

Following the initial release yesterday, and the coverage in the AFR, today we drill down further into the latest mortgage stress results.

By way of background, we have been tracking stress for years, and in 2014 we set out the approach we use. Other than increasing the sample, and getting more granular on household finance, the method remains the same, and consistent. We can plot the movement of stress over time.

Remember that the recent RBA Financial Stability review revealed that 30% of households were under pressure with no mortgage buffer, and a recent Finder.com.au piece suggested more than 50% were unable to cope with a $100 a month rise. So we are not alone in suggesting households are under greater financial pressure.

For this analysis we plot the number of households in mild stress (making mortgage repayments on time but tightening their belts so to do); severe stress (insufficient cash flow to pay the mortgage), and also an estimation of the number of households who may hit a 30-day default within the next 12 months. This is calculated by adding in a range of economic overlays into the stress data. This is all done in our core market model, which contains data from our rolling surveys, private data from lenders and other sources, and public data from the RBA, APRA and ABS. This model is unique in the Australian context because it runs at a post code and household segment level, allowing us to drill into the detail. This is important because averaging masks significant variations.

The analysis shows that there are more severely stressed households in NSW than other states, and that around 13,000 households risk default in the next year, a similar number to VIC. WA is third on this list, with the number of defaults lower elsewhere.

Another lens is by the locations of households, in the residential zones around our major cities. The highest risk of default resides in the our suburbs, where a higher proportion of households are in severe stress. Households in inner regional Australia are next, followed by the inner suburbs, where again more households are in severe stress.

Our core household segmentation shows that the highest count of defaults are likely among the suburban mainstream, then the disadvantaged fringe, followed by mature stable families and young growing families. It is also worth noting that the young affluent and exclusive professional, the two most affluent segments contain a number of severe stressed households. This have larger mortgages and lifestyles, but not necessarily more available cash.

Finally, for today, here is the mapping across the regions. No surprise that the largest number of stressed households are in the main urban centres of Melbourne and Sydney.

Next time we will look at post codes across the country.

Record numbers under mortgage stress

From The Australian Financial Review.

Record numbers of Australian households face mortgage stress as large loans and rising interest rates start to bite, according to detailed analysis of lending, repayments and household incomes.

Affluent suburban postcodes feature among an estimated 1000 households a week expected to face mortgage default over the next 12 months, the analysis reveals.

“Debt stress momentum is unprecedented,” according to Martin North, principal of research firm Digital Finance Analytics, who has been doing the survey for more than 15 years.

“This is not just about mortgage battlers. It is also hitting the households with bigger incomes and more leverage. It is worrisome,” Mr North said. Numbers of borrowers in severe distress has increased by about one-third to about 32,000 in the past 12 months, he said.

Concern that 767,000 households – or one-in-four across the nation – are facing financial distress follows last month’s warning by the Reserve Bank of Australia about increasing family “vulnerability” caused by soaring property prices, particularly in Melbourne and Sydney.

Reserve Bank assistant governor Michele Bullock said regulators may be forced to impose even heavier restraints on lenders to prevent the property market becoming the trigger for a disruptive financial crisis, said Reserve Bank assistant governor Michele Bullock.

Ms Bullock conceded that the effect of so-called macroprudential regulations imposed on the banks in 2015 to curb investor lending may be fading.

It also follows the Australian Securities and Investments Commission discovery that about 1.5 million recent loan applications matched minimum financial requirements, triggering concerns about lax lending standards.

Other prudential regulators are warning about the need to control interest-only lending because of concerns borrowers’ lack strategies for repaying principals, increasing vulnerability to financial stresses.

Digital Finance Analytics’ report is based on information from 52,000 household surveys and public data from the Reserve Bank of Australia, Australian Bureau of Statistics, Australian Prudential Regulation Authority and information from lenders and aggregators, which are companies that act as intermediaries between mortgage brokers and lenders.

Households are “stressed” when income does not cover ongoing costs, rather than identifying a percentage of income committed to mortgage repayments, such as 30 per cent of after-tax income.

Those in “severe distress” are unable to meet repayments from current income, which means they have to cut back on spending or rely on credit, refinancing, loan restructuring or selling their house.

Mortgage holders under “severe distress” are more likely to seeking hardship assistance and are often forced to sell.

“Stressed households are less likely to spend, which acts as a drag anchor on future economic growth,” said Mr North. “The number of households impacted are economically significant, especially as household debt continues to climb to new record levels.”

However lenders would be expected able to ride out a spike in arrears because they can foreclose on properties whose value has been inflated by unprecedented price growth.

State government budgets in the nation’s most populous states and territories have been boosted significantly by stamp duty charged on property transactions.

About 32,000 households are in severe distress, the analysis reveals. An additional 10,500 households in the suburban mainstream are in risk of default.

Other vulnerable community segments at risk of default include young growing families, the highly leveraged young ‘affluent’.

Most lenders are increasing rates for investors and toughening lending terms and conditions by increasing deposits and demanding more evidence that loans can be comfortably serviced by borrowers.

Commonwealth Bank of Australia, Westpac, National Australia Bank and Australian and New Zealand Banking Group have all raised investor rates in recent weeks.

Lenders are describing their strategy of slugging interest-only investors and easing pressure on principal and interest borrowers as the “new normal” because it differentiates between classes of borrowers as directed by regulators.

One In Three Households Have No Mortgage Buffer – RBA

The latest Financial Stability Review from the RBA has a different tone to it, compared with previous edition, because whereas they have previously played up the “cushion” some households have by paying their mortgages ahead, now they say one third of households have no buffer and are exposed to potential interest rate rises. What has changed is not the underlying data, but how it is being presented. Here are some key extracts.

In Australia, vulnerabilities related to household debt and the housing market more generally have increased, though the nature of the risks differs across the country. Household indebtedness has continued to rise and some riskier types of borrowing, such as interest-only lending, remain prevalent. Investor activity and housing price growth have picked up strongly in Sydney and Melbourne. A large pipeline of new supply is weighing on apartment prices and rents in Brisbane, while housing market conditions remain weak in Perth.

Nonetheless, indicators of household financial stress currently remain contained and low interest rates are supporting households’ ability to service their debt and build repayment buffers.

The Council of Financial Regulators (CFR) has been monitoring and evaluating the risks to household balance sheets, focusing in particular on interest-only and high loan-to‑valuation lending, investor credit growth and lending standards. In an environment of heightened risks, the Australian Prudential Regulation Authority (APRA) has recently taken additional supervisory measures to reinforce sound residential mortgage lending practices. The Australian Securities and Investments Commission has also announced further steps to ensure that interest-only loans are appropriate for borrowers’ circumstances and that remediation can be provided to borrowers who suffer financial distress as a consequence of past poor lending practices. The CFR will continue to monitor developments carefully and consider further measures if necessary.

Investor credit has also risen noticeably over the past six months, with investor demand particularly strong in Sydney and Melbourne (Graph 2.3).

Overall household indebtedness has increased while income growth has remained weak. Some types of higher-risk mortgage lending, such as IO loans, also remain prevalent and have increased of late.

The risks associated with strong investor credit growth and increased household indebtedness are primarily macroeconomic in nature rather than direct risks to the stability of financial institutions. Indeed, some evidence suggests that investor housing debt has historically performed better than owner-occupier housing debt in Australia, though this has not been tested in a severe downturn. Rather, the concern is that investors are likely to contribute to the amplification of the cycles in borrowing and housing prices, generating additional risks to the future health of the economy. Periods of rapidly rising prices can create the expectation of further price rises, drawing more households into the market, increasing the willingness to pay more for a given property, and leading to an overall increase in household indebtedness. While it is not possible to know what level of overall household indebtedness is sustainable, a highly indebted household sector is likely to be more sensitive to declines in income and wealth and may respond by reducing consumption sharply.

A further risk during periods of strong price growth is that it may be accompanied by an increase in construction that could result in a future overhang of supply for some types of properties or in some locations. In this environment, as well as amplifying the upswing for such properties, any subsequent downswing is likely to be larger and more likely to see prices and rents fall if the vacancy rate rises. This poses risks to the whole housing market and household sector, not just to the recent investors.

While the financial position of households has been fairly resilient, vulnerabilities persist for some highly indebted households, especially those located in the resource-rich states. Household indebtedness (as measured by the ratio of debt to disposable income) has increased further, primarily due to rising levels of housing debt, although weak income growth is also contributing. Rising indebtedness can make households more vulnerable to potential income declines and higher interest rates. This is of most concern for households that have very high levels of debt.

Low interest rates are helping to offset the cost of servicing larger amounts of debt and hence total mortgage servicing costs remain around their recent lows (Graph 2.5). In this regard, lenders have tightened mortgage serviceability assessments in recent years to include larger interest rate buffers, which should provide some protection against the potential effects of higher interest rates.

Prepayments on mortgages increase the resilience of household balance sheets. Aggregate mortgage buffers – balances in offset accounts and redraw facilities – are high, at around 17 per cent of outstanding loan balances or around 2½ years of scheduled repayments at current interest rates. However, these aggregate figures mask significant variation across borrowers, with available data suggesting that around one-third of borrowers have either no accrued buffer or a buffer of less than one month’s repayments. Those with minimal buffers tend to have newer mortgages, or to be lower-income or lower-wealth households.

Interest-only (IO) loans account for a sizeable and growing share of total housing credit in Australia, now representing around 23 per cent of owner‑occupier lending and 64 per cent of investor lending (Graph B1). IO lending has the potential to increase households’ vulnerability in part due to the higher average level of indebtedness over the life of an IO loan compared with a regular principal-and-interest (P&I) loan.

For some time regulators have highlighted the potential risks associated with IO compared with P&I loans. Because IO loans allow borrowers to remain more indebted for longer, there may be greater credit risks associated with such loans. When loan balances stay high, there is an increased risk of borrowers falling into negative equity should housing prices decline.

Another risk is that borrowers may find it difficult to service higher required payments at the end of the IO period, which increases the chance of default. For example, repayments on a $400 000 loan with a 4 per cent interest rate and a five-year IO period would typically increase by around 60 per cent at the end of the IO period. While some borrowers may have planned to refinance into another IO loan at the end of the IO period, this may be difficult if circumstances have changed.

Borrowers who anticipate future price rises can use IO loans to maintain a higher level of leverage for a given servicing payment, thereby magnifying their returns from rising housing prices but also magnifying any losses. More generally, at an aggregate level this behaviour could induce a more pronounced cycle in housing prices than would otherwise occur, amplifying the size of any subsequent downswing in housing prices.