A Morningstar report by David Ellis this week argues that Australia’s debt levels are far lower than expected when mortgage offset accounts are thrown into the mix.
The latest RBA data on household spending, released Monday, shows that the household debt-to-income ratio hit 190.4 in March – a record high.
However, Morningstar’s David Ellis believes the debt-to-income ratio would fall to 120 per cent if deposits and offset accounts were considered.
“When household deposits and loan offset account balances are taken into consideration, the average household debt/average disposable income ratio falls from 190 per cent to 120 per cent,” Mr Ellis said.
“But we expect that a large percentage of the loan offset account balances is in the hands of the wealthy minority, with the financial pressure for less well-off borrowers increasing as interest rates increase and wages growth remains very modest,” he said.
Loan offset account balances have increased strongly over several years, a feature that the Reserve Bank has highlighted repeatedly in its Financial Stability Reviews.
According to Morningstar, loan offset balances at March 31 were $25 billion for ANZ, $36 billion for CBA, $26 billion for NAB and $36 billion for Westpac. Analyst David Ellis noted that the offset account balances held by the majors are “all growing fast.”
The analysis comes amid fears over Australia’s debt levels at a time when banks are lifting interest-only (IO) rates in an effort to meet regulatory measures imposed by APRA.
IO mortgage growth has been significant but APRA’s actions and subsequent mortgage repricing form the banks are expected to slow this down considerably.
“Strong growth in interest-only mortgages is about to slow,” Mr Ellis said. “In the next five years, we expect interest-only loans will decline from current levels of around 35 to 40 per cent to 25 to 30 per cent.”
Australia’s love affair with IO loans stems from the tax benefits of negative gearing; the higher the interest payment, the larger the potential tax deduction for investors.
While IO loans have their advantages in a booming property market, risks begin to emerge when housing cools or prices start to decline.
“Interest-only loans are not without risk, and the concern is that interest-only borrowers will not be able to afford the higher monthly P&I repayments, and if house prices fall, equity in their properties could quickly turn negative,” Mr Ellis said.
However, he noted that when the banks make interest-only home loans, borrowers are assessed as if the loan is P&I: “So interest-only borrowers should theoretically be able to afford higher P&I repayments.”
Most IO loan terms are five years, at which point the mortgage switches over to P&I repayments.