Mortgage risks heightened by ‘unexpectedly low’ wage growth

In his opening keynote address to the CFO Forum on Tuesday (15 May), the deputy governor of the Reserve Bank, Guy Debelle, noted that mortgage risks have been heightened by slow wage growth, adding that, in the past, mortgage pressures were offset by inflation.

“One reason why I think debt remains high relative to income has been because income growth has been unexpectedly low,” the deputy governor said.

“In past decades, one of the easiest ways to pay down your mortgage was through inflation. Higher inflation was accompanied by higher wages growth.

“Because the mortgage is fixed in nominal terms, the debt level declined quite rapidly relative to a household’s income when incomes were growing quickly.”

Mr Debelle claimed that borrowers could be forced to tackle larger levels of mortgage debt for a longer period of time.

“Household income growth has been subdued for a number of years, which means that a number of households may be carrying a larger mortgage for longer than they expected when they took out the loan,” Mr Debelle continued.

“While they can service the mortgage, it has consumed a larger share of their income for longer than they might have intended.”

Tighter lending to limit borrowing capacity

The RBA assistant governor also noted that further tightening of lending standards would have an impact on borrowing capacity.

“There is a risk of a further tightening in lending standards in the period ahead,” Mr Debelle added.

“This may have its largest effect on the amount of funds an individual household can borrow, more than the effect on the number of households that are eligible for a loan.”

However, Mr Debelle said that he expects tighter credit practices to have a greater impact on home values.

“This, in turn, means that credit growth may be slower than otherwise for a time. To me, that has more of an implication for house prices than it does for the outlook for consumption.”

Households to withstand rate hike

Mr Debelle also downplayed the threat that a future rate hike from the RBA would pose to borrowers.

“Finally, in thinking about the resiliency of household balance sheets to higher interest rates, it is important to think about the environment in which interest rates would be rising,” Mr Debelle said.

“That environment is highly likely to be one where wages and household incomes are also growing faster than currently, improving the ability of households to afford higher mortgage repayments.”

The Reserve Bank has warned of several potential impacts on mortgages in recent months. Last month, RBA assistant governor (financial markets) Christopher Kent suggested that borrowers approaching the expiry of their interest-only home loans period could be required to fork out an additional $7,000 a year.

The RBA assistant governor added that the “non-trivial’ step-up in mortgage repayments would make up 7 per cent ($120 billion) of the total housing credit outstanding.

Mr Kent warned that such risks would have an adverse effect on borrowers and lenders alike, with some borrowers particularly at risk in the event of a “shock” to the broader Australian economy.

“If the borrower has made no provisions and is unable to make the necessary adjustment, they may need to sell the property to repay the loan. Therein lies an additional risk inherent in interest-only lending.

“Moreover, the borrower’s ability to service the loan is not fully tested until the end of the interest-only period.

“If the borrower defaults, the potential loss for the lender will be larger than in the case of a P&I loan, given that interest-only loans by design allow borrowers to maintain the debt at a higher level over the term of the loan.”

Mr Kent also echoed a view expressed by ratings agency Standard and Poor’s (S&P) that owner-occupier borrowers are exposed to greater risk than investors following the expiry of the IO term.

“The most vulnerable are likely to be owner-occupiers, with high LVRs, who might find it more difficult to refinance or resolve their situation by selling the property,” Mr Kent said.

[Related: Investors ‘spooked’ as loan demand drops]