In her address to the Responsible Lending and Borrowing Summit on Tuesday (20 February), the assistant governor of the Reserve Bank of Australia (RBA), Michele Bullock, spoke about household indebtedness and mortgage stress.
Ms Bullock said that while mortgage stress has declined since 2011 (largely as a reflection of the fall in interest rates since that time) and that the number of those classed as being in some financial stress is “not growing rapidly”, around 12 per cent of owner-occupiers with mortgage debt indicated that they would expect difficulty raising funds in an emergency.
“Lending standards have erred on the more relaxed side”
One area that Ms Bullock particularly focused on was interest-only (IO) loans and the ability of mortgagors to repay the principal of these loans following the expiry of the IO period.
Noting that “the increasing popularity of interest-only loans over recent years meant that, by early 2017, 40 per cent of the debt did not require principal repayments”, the assistant governor said that “this presents a potential source of financial stress if a household’s circumstances were to take a negative turn”.
Notably, Ms Bullock revealed that regulators — in the past few years — have been “concerned that lending standards have erred on the more relaxed side”, adding: “An exuberant housing market in some parts of the country and strong competition among lenders raised the question of whether financial institutions had been appropriately prudent in assessing a household’s ability to meet repayments.
“In response, a number of measures were implemented by APRA and ASIC to strengthen mortgage lending standards. These measures have helped improve the quality of lending over the past couple of years. But there is still a large stock of housing debt out there, some of which probably would not meet the more conservative lending standards currently being imposed.”
Ms Bullock noted that as a “large portion” of principal-free periods begin to expire, some borrowers may therefore struggle to service their mortgages.
She said: “[A] large proportion of interest-only loans are due to expire between 2018 and 2022. Some borrowers in this situation will simply move to principal and interest repayments as originally contracted.
“Others may choose to extend the interest-only period, provided that they meet the current lending standards. There may, however, be some borrowers that do not meet current lending standards for extending their interest-only repayments but would find the step-up to principal and interest repayments difficult to manage.
“This third group might find themselves in some financial stress. While we think this is a relatively small proportion of borrowers, it will be an area to watch.”
Investors that sell in downturn could “impact the housing wealth of all home owners”
Moreover, Ms Bullock said that in the event of a continued fall in housing prices, investors with IO loans could impact the overall wealth of home owners.
She explained: “[M]any [investors] take out interest-only loans so that their debt does not decline over time.
“If housing prices were to fall substantially, therefore, such borrowers might find themselves in a position of negative equity more quickly than borrowers with an equivalent starting LVR that had paid down some principal.
“Indeed, the macro-financial risks are potentially heightened with investor lending. For example, since it is not their home, investors might be more inclined to sell investment properties in an environment of falling house prices in order to minimise capital losses.
“This might exacerbate the fall in prices, impacting the housing wealth of all home owners.”
Ms Bullock also noted that due to the fact that investors purchase more new dwellings than owner-occupiers, they might also “exacerbate the housing construction cycle, making it prone to periods of oversupply and having a knock-on effect to developers”.
She added that there had also been “a marked increase in the share of geared housing investors who are over 60”, and that while these factors “do not necessarily increase the risk of financial stress”, they bear “watching”.
“Risks to financial stability remain low”
However, despite raising concern over a possible rise in financial stress as a result of record high household indebtedness, Ms Bullock believes that the financial system is well equipped to manage potential risks.
“The information we have suggests that, while there are some pockets of financial stress, the overall level of stress among mortgaged households remains relatively low,” the assistant governor said.
“Furthermore, the banking system is strong and well capitalised, and is supported by prudent lending standards.
“The risks to financial stability from this source therefore remain low, although we will need to keep an eye on developments.
“Appropriately prudent lending standards will continue to play an important role in ensuring that the financial system remains stable and households borrow responsibly.”
[Related: APRA endowed with new crisis powers]
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Charbel Kadib is the news editor on the mortgages titles at Momentum Media.
Before joining the team in 2017, Charbel completed internships with public relations agency Fifty Acres, and the Department of Communications and the Arts.