We discussed the mortgage rate sensitivity analysis we recently completed on News 24 tonight.
Tag: Mortgage Stress
One in five homeowners will struggle with rate rise of less than 0.5%
ONE in five Australians are walking such a fine mortgage tightrope that they could lose their homes if interest rates rise by even 0.5 per cent.
Our love affair with property has pushed Australia’s residential housing market to an eye-watering value of $6.2 trillion.
But as we scramble over each other to snap up property while interest rates are at historic lows, we have gotten ourselves into a bit of a pickle. We might not actually be able to afford funding our affair.
An analysis, based on extensive surveys of 26,000 Australian households, compiled by Digital Finance Analytics, examined how much headroom households have to rising rates, taking account of their income, size of mortgage, whether they have paid ahead, and other financial commitments. And the results are distressing.
It showed that around 20 per cent — that’s one in five homeowners — would find themselves in mortgage difficulty if interest rates rose by 0.5 per cent or less. An additional 4 per cent would be troubled by a rise between 0.5 per cent and one per cent.
Almost half of homeowners (42 per cent) would find themselves under financial pressure if home loan interest rates were to increase from their average of 4.5 per cent today to the long term average of 7 per cent.
“This is important because we now expect mortgage rates to rise over the next few months, as higher funding costs and competitive dynamics come into pay, and as regulators bear down on lending standards,” Digital Finance Analytics wrote.
The major banks have already started increasing their home loan rates this year, despite the market broadly expecting the Reserve Bank to keep the cash rate steady at 1.5 per cent this year.
Just this week NAB upped a number of its owner-occupied and investment fixed rate loans.
“There are a range of factors that influence the funding that NAB — and all Australian banks — source, so we can provide home loans to our customers,” NAB Chief Operating Officer, Antony Cahill, said of the announcement.
“The cost of providing our fixed rate home loans has increased over recent months.”
So as interest rates rise and leave mortgage holders in its dust, it leaves a huge section of society, and our economy, exposed and at risk.
NOT TERRIBLY SURPRISING
Martin North, Principal of Digital Finance Analytics, said the results are concerning, albeit not surprising.
“If you look at what people have been doing, people have been buying into property because they really believe that it is the best investment. Property prices are rising and interest rates are very low, which means they are prepared to stretch as far as they can to get into the market,” Mr North told news.com.au.
But the widespread assumption that interest rates will remain at historic lows is a disaster waiting to happen, especially in an environment where wage growth is stagnant.
“If you go back to 2005, before the GFC, people got out of jail because their incomes grew a lot faster than house prices, and therefore mortgage costs. But the trouble is that this time around we are not seeing any evidence of real momentum in income growth,” Mr North said.
“My concern is a lot of households are quite close to the edge now — they are not going to get out of jail because their incomes are going to rise. We are in a situation where interest rates are likely to rise irrespective of what the RBA does … There has already been movement up.”
Australia’s wages grew at the slowest pace on record in the three months to September 2016, according to the latest Wage Price Index released by the Australian Bureau of Statistics (ABS).
And as a result Australia’s debt-to-income ratio is astronomical. The ratio of household debt to disposable income has almost tripled since 1988, from 64 per cent to 185 per cent, according to the latest AMP. NATSEM Income and Wealth report.
What this means is that many Australian households are highly indebted, thanks in large part to the property market, without the income growth to pay it down.
“The ratio of debt to income is as high as it’s ever been in Australia and there are some households that are very, very exposed,” Mr North said.
THE YOUNG AND RICH MOST AT RISK
This finding will come as a surprise: young affluent homeowners are the most at risk — it is not just a problem with struggling families on the urban fringe. When it comes to this segment of the market, around 70 per cent would be in difficulty with a 0.5 per cent or less rise. If rates were to hike 3 per cent, bringing them to around the long term average of 7 per cent, nine in ten young affluent homeowners would feel the pressure.
“It is not necessarily the ones you think would be caught. And that’s because they are actually more able to get the bigger mortgage because they’ve got the bigger income to support it.
“They have actually extended themselves very significantly to get that mortgage — they have bought in an area where the property prices are high, they have got a bigger mortgage, they have got a higher LVR [loan-to-valuation ratio] mortgage and they have also got lot of other commitments. They are usually the ones with high credit card debts and a lifestyle that is relatively affluent. They are not used to handling tight budgets and watching every dollar.”
And while the younger wealthy segment of the market being most at risk might not be of that much importance compared to other segments, Mr North said what is concerning is the intense focus on this market.
“Any household group that is under pressure is a problem for the broader economy because if these people are under pressure they are not going to be spending money on retail and the broader economy,” Mr North told news.com.au.
“The banks tend to focus in on what they feel are the lower risk segments and the young affluent sector has actually been quite a target for the lending community in the last 18 months. Be that investment properties or first time owner-occupied properties, my point is there is more risk in that particular sector than perhaps the industry recognises.”
TOUGHER HOME LOAN RESTRICTIONS NEEDED
Now an argument is mounting that Australian banks need to toughen up their approach to home lending.
“I think we have got a situation where the information that is being captured by the lenders is still not robust enough. I am seeing quite often lenders willing to lend what I would regard as relatively sporty bets … I’m questioning whether the underwriting standards are tight enough,” Mr North said.
This includes accepting financial help from relatives for a deposit, a growing trend among first home buyers.
“The other thing that I have discovered in my default analysis is that those who have got help from the ‘Bank of Mum and Dad’ to buy their first property are nearly twice as likely to end up in difficulty … It potentially opens them to more risk later because they haven’t had the discipline of saving.”
News.com.au contacted several banks for comment on whether they think a rethink of their underwriting standards is needed. Only one lender, Commonwealth Bank, agreed to comment, but remained vague on the topic.
“In line with our responsible lending commitments, we constantly review and monitor our loan portfolio to ensure we are maintaining our prudent lending standards and meeting our customers’ financial needs. Buffers and minimum floor rates are used when assessing loan serviceability so it is affordable for customers,” a CBA spokesman said in an emailed statement.
But Mr North said something needs to be done before we find ourselves in a property and economic downturn.
“I’m assuming that with the capital growth we have seen in the property market, it will allow people who get into significant difficulty to be able to get out, however, it’s the feedback concern that I’ve got.
“If you have got a lot of people in the one area struggling with the same situation, you might see property prices begin to slip. If we get the property price slip, and we get unemployment rising and interest rates rising at the same time, we have that perfect storm which would create quite a significant wave of difficulty.
“We need to be thinking now about how to deal with higher interest rates down the track. We can’t just say it will be fine because it won’t be,” he told news.com.au.
US Mortgage Rates Add Stress for Millennial Homebuyers
Fitch Ratings says the recent rise in US interest rates adds another obstacle for millennials seeking to enter the housing market.
Based on our calculations, the rate increase means the average US millennial borrower now has lost 9% in mortgage capacity since the beginning of October 2016. This leaves more millennials out of what has historically been one of the most important wealth-creation mechanisms, and could contribute to long-term shifts in savings and consumption.
Mortgage rates nearly hit a two-year high during the week of Jan. 5, 2017 according to Freddie Mac. The interest rate on a 30-year mortgage at the beginning of October 2016 was 3.42%. Last week, the rate climbed to 4.20%. The maximum loan a homebuyer could afford in September 2016 was $120,000 (the current median mortgage for borrowers under 35 according to the Federal Survey of Consumer Finances), all else being equal, the size of that loan would have dropped to approximately $109,000 by last week.
Historically low rates have been one of the few factors that have helped young adults to buy homes. If rates continue to rise, particularly if the rise occurs rapidly over a short time period, this could add yet another obstacle to homeownership. Many first-time homebuyers have seen mortgage capacity eroded by tight loan underwriting standards, rising student loan payments, high rents and stagnant wages.
The growth in the cost of higher education outpaced consumer price inflation for several decades. This led to an increase in both the number of student loan borrowers and the average amount owed. The median student loan monthly payment in 2016 was $203, according to the Federal Reserve Bank of Cleveland.
Tight underwriting played a significant role. Banks remain vigilant over regulatory risk, repurchase risk and the increased cost of servicing of delinquent loans. This means FICO scores for conventional loans to first-time homebuyers remain notably above the 720-730 range level typical prior to the crisis, although the scores have begun trending back toward historical averages.
The stresses are reflected in the US homeownership rate and increases in the portion of millennials who live at home. The homeownership rate for under 35-year-olds experienced a large drop, declining to 35% in 2016, from 41% in 2000, according to the US Census Bureau. During this time, rental costs increased faster than the incomes millennials earn.
For younger Americans forced to defer or abandon plans to buy a first home, the long-term financial effect of missing out on home-equity creation could be significant. Long-lasting shifts in savings and consumption patterns, while difficult to isolate now, will likely emerge more prominently in the coming years. This could mean other long-run affects including downward pressure on durable goods consumption, urban population growth and a decline in affluence, translating into lower birth rates and less secure retirements.
How Households Will Respond To Interest Rate Rises
We have updated our analysis of how sensitive households with an owner occupied mortgage are to an interest rate rise, using data from our household surveys. This is important because we now expect mortgage rates to rise over the next few months, as higher funding costs and competitive dynamics come into pay, and as regulators bear down on lending standards.
To complete this analysis we examine how much headroom households have to rising rates, taking account of their income, size of mortgage, whether they have paid ahead, and other financial commitments. We then run scenarios across the data, until they trip the mortgage stress threshold.
At this level, they will be in difficulty. The chart shows the relative distribution of borrowing households, by number. So, around 20% would have difficulty with even a rise of less than 0.5%, whilst an additional 4% would be troubled by a rise between 0.5% and 1%, and so on. Around 35% could cope with even a full 7% rise.
If we overlay our household segments, we find that young growing families and young affluent households are most exposed to a small rate rise. However, some in other segments are also at risk.
State analysis highlights that households in NSW are most sensitive, a combination of larger volumes of loans as well a larger loans, relative to incomes resulting is less headroom.
Younger households are relatively more exposed, because their incomes tend to be more limited and are not growing in real terms relative to mortgage repayments.
Analysis by DFA property segment shows that whilst some first time buyers are exposed at low rate movements, those holding a mortgage with no plans to change their properties (holders) are also exposed. In addition, some seeking to refinance are doing so in the hope of reducing payments, because they have limited headroom.
Finally we turn to other insights from our data. First, those households who sourced their mortgage via a mortgage broker are more likely to be in difficulty with a small rate rise, compared with those who went direct to a bank. This, once again, shows third party loans are more risky. This perhaps is connected to the types of people using brokers, as well as the broker’s ability to suggest lenders with more generous underwriting standards and coaching on how to apply successfully.
We also see that rate seekers (we call these soloists) who are driven primarily by best rates, are more sensitive to small rate rises, compared with those who are more inclined to seek advice, and appreciate service more than price (we call these delegators).
Soloists who went via a broker are the most exposed should rates rise even a little, whereas delegators going to a bank, are more able to handle future rises.
Segmentation, effectively applied can results in quite different portfolio outcomes!
The Full 100 Mortgage Stress Listing
To complete our series on mortgage stress, based on our household surveys, here is the complete list of the top 100 most stressed suburbs, and their relative position on the default list, as at December 2016.
Victoria has the highest number of suburbs in the listing.
As we discussed yesterday, this is based on the absolute number of households in the suburb who are in difficulty. You can also watch our video blog where we discuss the research.
Running our risk models, we expect the banks to be reporting higher mortgage defaults next year, with a lift in write-offs from around 2 basis points, to 4 basis points. However, this is still at a low, and manageable level given the capital buffers they hold. We do expect provisions though to rise.
Fears rise as mortgage stress strikes bush, city
In Lamington, a country area of Western Australia covering mining towns such as Kalgoorlie, 2600 households are suffering “mortgage stress”.
The pain is more severe in Harristown in Queensland, about 130km west of Brisbane, where more than 4500 households are in difficulty.
For the banks, more than 370 in these areas alone are likely to default, or fall more than 30 days behind on repayments, according to data from Digital Finance Analytics.
Research covering the top 20 postcodes with the greatest mortgage stress features many country areas but Melbourne’s Essendon and Preston each have around 2500 households in difficulty, as does western Sydney’s Bossley Park.
Despite record low interest rates and unemployment below 6 per cent, Standard & Poor’s yesterday said arrears ticked higher in October and the proportion of “non-conforming” borrowers behind on payments was near record levels.
DFA’s data, based on a rolling survey of 2000 households a month, suggests the trend will worsen. It also suggests first time home buyers who received help from the “bank of mum and dad” were more likely to default.
“The issue will be what happens to interest rates. If interest rates don’t go up, then some of this won’t flow through, but I think all the expectations are that interest rates will rise,” said DFA analyst Martin North, who is factoring in a 50 basis point increase in rates next year.
Banks in recent weeks have hiked mortgage rates for many customers out of sync with any RBA changes, which analysts said could put customers under greater pressure amid meagre income growth.
Mr North said: “My own models predict a higher rate of loss than they (banks) are currently predicting themselves.”
The RBA yesterday signalled borrowers were unlikely to win any imminent reprieve on their debt repayments early next year.
After cutting rates since late 2011, the RBA’s minutes of its monthly board meeting revealed greater concern about the “balance” between low rates supporting economic growth and the “potential risks to household balance sheets”.
“Members recognised that this balance would need to be kept under review,” the RBA said.
Westpac chief economist Bill Evans said the RBA was concerned the benefits to spending from lower rates were not compensating for the instability in asset markets, heightened by record high household debt.
“This observation is signalling that the hurdle to even lower rates which would be aimed at boosting demand is very high,” he said. As house prices soared more than 65 per cent in Sydney in the past four years while floundering in other areas, some hedge funds and analysts have flagged overgeared households and a sagging real economy were increasing the risks of a housing correction.
US-based asset manager AllianceBernstein yesterday warned that potential “disorder” in the housing sector in the second half of next year clouded the outlook for Australia’s investment markets. Former Commonwealth Bank chief David Murray this month said all the signs of a housing “bubble” were prevalent, such as “people’s behaviour … and defensiveness about any correction”.
Mr Murray told Sky Business that investors owning multiple properties that were cross-collateralised who could become forced sellers were the “risk to the system”. But the big banks have repeatedly tried to ease fears about the risks, citing relatively low unemployment and most customers being ahead on their loan repayments.
Westpac last month reported actual mortgage losses after insurance eased to $31 million, or just 2 basis points of its loan book. The number of consumer properties in possession rose to 262, from 253 in March.
ANZ and Bank of Queensland, however, recently flagged concerns about stagnant wages, underemployment and the apartment glut in eastern cities.
According to DFA’s survey, around 80 per cent of households were travelling well and only 20 per cent were under stress, struggling to make repayments or having to cut back on spending.
Mr North said low wages growth and rising education and healthcare costs suggested borrowers’ financial situations would not improve. He predicted the banking industry’s loss rates would rise to about 4 basis points of mortgage loans, varying among lenders’ portfolios.
He said banks concentrated in troubled areas, such as WA, would be harder hit.
After the pick-up in bank stock prices since last month, CLSA analysts yesterday reminded investors that all were at risk of favourable loan-loss trends of recent years reversing and that CBA was more exposed than peers to WA.
WA has the largest proportion of stressed households at 26.4 per cent, just ahead of Victoria, but off a smaller population base, according to DFA’s survey.
Mr North said: “I’m theorising there is more risk in the mortgage book than I think the RBA recognises and more risk than some of the risk models used by the banks. It’s not dramatic … I’m not saying the world is caving in. 80 per cent of the book is fine.
“But it’s enough to at least be aware of.”
New DFA Video Blog – Household Mortgage Stress and Defaults
Using data from our household surveys in this new video blog we discuss the findings from our latest modelling. More than 22% of households are currently in mortgage stress, and 1.9% of households are likely to default. Both are likely to rise next year.
Top 20 Postcodes For Mortgage Stress Across Australia
Now we get to the pointy end of our mortgage stress and default analysis. Today we list the top 20 post codes across Australia where the highest number of households currently in mortgage stress reside. We also reveal our estimate for the number of defaults which we expect to occur in the coming months.
It is worth saying that the percentage of households stressed or at risk of default, in a particular post code, varies considerably, but we have chosen to look at the actual number of households this represents. This is because there are a number of post codes where the percentage is very high, but off a very low number of householders. Statistically speaking such low numbers would make us less certain of the accuracy of the estimates. But by choosing to focus on the absolute number of households involved, the estimates are more firmly grounded. In any case the numbers involved, if larger, makes a material difference to the economy, and the banking system.
So, then, here is the list. The post code with the highest number of households in mortgage stress in December 2016 is Harristown – 4350 – in Queensland. It is about 109 kms from Brisbane. This area covers Toowoomba, Harristown, Glenvale and Rockville etc and a population of close to 60,000. Many of the households here are younger. Incomes are lower than the QLD average. More than 4,500 households there are in difficulty and more than 170 households in the district risk mortgage default.
Within the top 20 nationally, the post code with the highest level of default risk is Lamington, WA, a suburb of South East & Central. It is about 549 kms from Perth. The region includes Kalgoorlie, Lamington and Williamstown, etc. Many of these households are in the younger aged segments. Incomes are higher than the WA average. Here more than 2,600 households are in mortgage stress, and more than 200 are likely to default.
The distribution of stressed households in also interesting. Within the top 20, Western Australia has the largest number of households (26.4%), just ahead of Victoria (26.38%), but off a smaller population base. Shows the pressure on households in the west.
Next time we will look in more detail at some the state levels data.
A Segmented View Of Mortgage Stress and Default
As we continue our series on mortgage stress, using the latest data from our surveys, we look at how stress aligns with our core household and property owning segments.
To set the context for this, here are a couple of charts showing the mortgage distribution by income and age bands. The majority of mortgages are held by households with an income of between $50,000 and $150,000.
Mortgage stress and default are slightly higher across the lower income bands, but note that households with substantially higher incomes can also be in severe stress. But of course the absolute number are very small.
The highest proportion of mortgages are held by those aged 30-39, more than 30%.
Default probability is higher among younger and older households. Whilst the number of these households with a mortgage is relatively low, more are in severe mortgage stress because their incomes are much lower. More generally, some mortgage stress is evident across all age bands. In volume terms, the highest stress volumes are found in those 30-39 years.
Next we turn to our property segmentation. Those holding property account for the largest segment of the market. You can read about our segmentation approach here.
Probability of default is highest among first time buyers, who also have the highest proportion of severe mortgage stress. The segment with the lower risk and levels of stress are those seeking to trade up.
On interesting finding, bearing in mind we highlighted the rise of first time buyers seeking help from “The Bank of Mum and Dad“, is that those who do get help are more likely to default. So, assistance from parents may be a two-edged sword.
Finally, we turn to our master segmentation. The number of households with a mortgage varies across these segments. The value distribution footprint is quite different, with the exclusive professional and young affluent segments holding the larger average mortgage.
Mortgage stress is highest among the disadvantaged fringe, though their mortgages are relatively lower and default rates are relatively low. Wealthy seniors registered high levels of severe mortgage stress, thanks to pressure on incomes (the impact of low returns from bank deposits and rentals are important here).
However, the highest risk of defaults sits with the younger segments. Young affluent households, with large mortgages are most exposed because their incomes are flat whilst they are highly leveraged, so as interest rates rise, they are exposed. Many have bought new high-rise apartments in the inner city areas.
Young growing families may have, on average smaller mortgages, but their finances are tight, with little room to maneuver, and any rise in interest rates will be a problem for them. Costs are living are moving higher for this group, especially child care costs.
So, we think effective segmentation is critical to understand the various portfolio risks which reside in the bank’s mortgage book. We need to move beyond LVR and LTI.
Next time we will look at some of the post code level data.
Mortgage Stress And Probability Of Default Is Rising
We have just finished the December update of our mortgage stress and probability of default modelling for the Australian mortgage market.
Our model has been updated to take account of the latest employment, wage, interest rate and growth data, and we look are the current distribution of mortgage stress (can households settle their mortgage repayments, on time without financial pressure?) and make an estimate of the probability of households defaulting on their repayments by more than 30 days. The former uses our survey data on mortgages held, interest rates applied, and income available in the light of other financial commitments. Probability of default overlays the broader economic drivers. The base analysis is completed at a customer segment level by post code then rolled up to form various data views. In the next few days, we will discuss the findings in some detail. You can read more about our approach here. We also also reveal the current top 100 post codes for mortgage stress and mortgage defaults across the nation.
To begin, here is a summary by states, split down by CBD and rest of state.
The highest probability of default can be found in regional WA, thanks to pressure in the mining belt. 30 days defaults will be close to 4%. Here, around 25% of households are in mortgage stress, including some in severe stress – see our descriptions here.
Default expectations are also high in and around Perth, where employment prospects are faltering, and incomes under pressure. In QLD, away from Brisbane, we see similar issues. The ACT has the lowest level of default probability.
The highest levels of mortgage stress are found in Tasmania, and across Regional NT, where more than 30% of households are under pressure. We also see hot spots in regional areas.
Of note is the high proportion of households in greater Sydney in severe mortgage stress – at 6.2% of borrowing households. This is a function of large mortgages (driven by high prices), rising interest rates AND flat incomes. By way of comparison, Melbourne households in severe stress sit at 3.3%, as mortgages are a little smaller. They are both higher than the national average of 2.8% of households.
Combined, across the country, more than 22% of all households are now in some degree of mortgage stress.
Next time we will dig into the more specific geographic footprints, because you really have to get granular to make sense of what is going on. Averages across the national simply mask what is going on. Later will will look at loan-to-income and debt servicing ratios which are also deteriorating for many. Then finally we will look at the loss implications for the banking sector.