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Mortgage delinquencies to rise as IO loans convert to P&I

Moody’s Investors Service has warned that Australian mortgage delinquencies will rise over the next few years as a record number of interest-only loans are scheduled to convert to principal and interest (P&I) in 2019 and 2020.

In its latest report on the Australian RMBS market, released on Thursday (2 August), Moody’s pointed to its own data which shows that the 90 days past due delinquency rate for mortgages that have converted to P&I from IO is 0.94 of a percentage point, double that of IO loans that have not yet converted, and 0.24 of a percentage point higher than all securitised mortgages.

“Banks originated a significant volume of IO loans in 2014 and 2015, which means a record number of these loans are scheduled to convert to P&I over 2019 and 2020, when the five-year IO period ends,” the ratings agency said.

“IO loans accounted for more than 40 per cent of all mortgages originated by banks for much of 2014 and 2015, with this figure peaking at 46 per cent in June 2015.”

The long-term average for the share of IO loans originated by banks is around 35 per cent.

“The origination of IO loans dropped substantially after 2015 in response to regulatory measures introduced to limit the origination of riskier loans,” Moody’s said.

Regulatory measures introduced to reduce risks in the mortgage market have curbed the origination of IO loans, making it more difficult for borrowers to refinance their loans at the end of the IO period or extend the IO period for another term with the same lender.

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Moody’s said that more difficult refinancing conditions will contribute to an increase in mortgage delinquencies as the IO period on a record number of IO loans ends over the next two to three years.

“House prices will also be an important determinant of how mortgages will perform when IO periods end, particularly in circumstances when borrowers need to refinance, extend the IO term or sell their properties,” the ratings agency said.

“If house prices are declining when IO loan terms end, this will increase borrowers’ loan/value ratios and further limit their ability to refinance or result in a loss upon the sale of the property.”

Australian house prices have declined by an average of 0.8 of a percentage point over the past 12 months, after increasing by just over 30 per cent over the previous five years.

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