Tag: Rate Headroom

Where Rate Rises Will Hit The Hardest

It seems that eventually mortgage rates will rise in Australia, as global forces exert external pressure on the RBA, and as the RBA tries to normalise rates (at say 2% higher than today). Timing is, of course, not certain.

But it is worth considering the potential impact. While our mortgage stress analysis takes a cash flow view of household finances, our modelling can look at the problem another way.

One algorithm we have developed is a rate sensitivity calculation, which takes a household’s mortgage outstanding, at current rates, and increments the interest rate to the point where household affordability “breaks”.  We use data from our household survey to drive the analysis.

We have just run this analysis with data to end October 2017. We will explore the top line results, and then drill into some NSW specific analysis.

So we start with the average across the country. We find that around 10% of households would run into affordability issues with less a 0.5% hike in mortgage rates,  and around another 8% would be hit if rates rose 0.5%, and a larger number would be added to the “in pain” pile, giving us a total of around 25% of households across the country in difficulty if rates went 1% higher. [Note that the calculation does not phase the rate increases in]. Around 40% of households would be fine even if rates when more than 7% higher.

We can run a similar calculation at a state level. The chart below shows the relative impact on less than 0.5%, 0.5% and 1% rate rises, giving a cumulative total.  We find that around 40% of households in NSW would have a problem, compared with 27% in VIC and 24% in WA.

We can also take the analysis further, to a regional view across the states. This reveals that the worst impacted areas would be, in order, Greater Sydney, Central Coast, Curtain and Greater Melbourne. These are all areas where home prices relative to income are significantly extended, thus households are highly leveraged.

Now lets look further at NSW. Here is the NSW footprint, including all the rate increase bands. More than 30% are protected even if rates are 7% or more higher.

We can look at the type of households, using our segmentation modelling.  Many will expect households in the disadvantaged areas of Greater Sydney to be worst hit by rate rises. This however is not the case, simply because they have smaller mortgages, lenders have lent cautiously, and because these households are use to handling difficult cash flows. Despite this, around 8% of households would be hit hard by a 1% rise in mortgage rates, enough to be a problem, but probably a lower proportion than would be expected.

However, young growing families have more of an issue (this will include a number of first time buyers), with around 35% in difficulty in the case of just a small rise, and more than 60% at risk at 1% higher than today.  Loans are relatively large compared with incomes (which are not rising faster than cpi).

But the segment with the most significant exposure is the Young Affluent household group. These households, which also includes some first time buyers, have larger incomes, but also larger mortgages, and are leveraged significantly, such that more than 70% of this group would struggle with a small rise. More than 85% would have issues with a 1% rate rise.

Many of these households have bought new high-rise apartments in the inner suburban ring, for example around Bondi, Wolli Creek and Hurstville.

So, in a rate increase scenario, we think specific households and locations will be disproportionately hit. The banks should be incorporating this type of analysis in their risk scenario models and underwriting standards. We think some are still lending too generously. The ~7.25 rate floor is not enough to protect borrowers or  the bank.

 

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!

A Deep Dive On Household Rate Sensitivity

Today we look at a Interest Rate Sensitivity – a specific slice of data from our household surveys which we use to drive the mortgage stress data series, as we discussed recently.

Using data from our surveys we are able to estimate the amount of headroom households would have if mortgage interest rates were to rise. We are expecting rises through 2017.

We look at a range of scenarios, and as rates rise estimate the “pain point” for specific households, taking into account their other commitments, income, type of loan and mortgage repayments. Today we look at owner occupied loans.

Looking at sensitivity by age of household, more than 65% of those under 40 years with a mortgage would have difficulty if rates rose just 0.5% (50 basis points).  Households who are older, on average have more headroom. In the “more than 7%” category, 60% of households are over 40 years.

Another interesting cut is the penetration of Lenders Mortgage Insurance (LMI). Around half of households with an LMI protected loan (remember the LMI Insurance protects the BANK, not the Household) would have difficulty if rates rose bu 50 basis points. Households with no need for LMI (normally because they have a lower loan-to-value ratio) have more headroom.

We see from our property segmentation that a greater proportion of first time buyers would be caught if rates rose 50 basis points, but property holders are the largest segment at the high end of the risk profile.

A look at our master segments shows that young growing families and young affluent households are relatively the most exposed if rates rise. Interestingly our battling urban, and disadvantaged fringe groups (who would generally be regarded as the worst credit risk) have more headroom. This is because they have smaller mortgages, so are less leveraged.

By state, NSW have the highest proportion of households which would be exposed by a 50 basis point rise – again because of large mortgages and high home prices.  By comparison, households in QLD AND VIC have more headroom.  Some households in WA are also exposed at 50 basis points.

Finally, we also see that the majority of households we identified as in severe mortgage stress appear in the band who would be under pressure if rates rose just 50 basis points. This is a validation of our modelling, and shows the alignment between mortgage stress and rate movements.

A further illustration of the power of effective segmentation!