Mortgage arrears lift amid tightening serviceability

According to the latest data from S&P Global Ratings, mortgage arrears in Australia are slowly rising as borrowers face increasing financial challenges.

The credit ratings agency’s quarterly market overview for March 2023 revealed a rise in both prime and non-conforming mortgage arrears during the first quarter of the year.

Prime mortgage arrears reached 0.95 per cent in March 2023, approaching the long-term average above 1.0 per cent.

This marked an increase from 0.76 per cent in December 2022 and 0.65 per cent in November of the same year.

Non-conforming loans, which are considered riskier, also experienced a rise in arrears, reaching 3.70 per cent in March, up from 3.20 per cent in December 2022.

While built-up savings and strong job growth had initially helped mitigate the increase in arrears, the situation is gradually shifting as the rising cost of living has started to erode borrowers’ savings buffers.

The Reserve Bank of Australia’s (RBA) June monetary policy decision adds to the uncertainty, by raising the cash rate to 4.1 per cent.

Despite the growing arrears, both in the prime and non-conforming sectors, the report emphasized that they are still below long-term averages.

However, the increasing difficulty in refinancing conditions could further contribute to rising arrears, as borrowers may struggle to manage their financial stress by refinancing and reducing their loan repayments.

Refinances become more challenging

Indeed, refinance activity has reached record levels in recent months, indicating that borrowers are actively seeking better deals.

However, following the notable decline in April, the report warned refinancing could become tougher for highly leveraged borrowers, especially with lenders assessing borrowers on a 3 per cent serviceability buffer.

While competitive refinancing conditions, along with savings buffers and a strong labour market, have supported borrower resilience, tighter refinancing conditions could continue to weigh on mortgage arrears, S&P Global Ratings analyst Erin Kitson said.

“This is likely to add to arrears pressure because refinancing is a common way for borrowers to self-manage their way out of financial stress,” Ms Kitson said.

In addition, the report showed prime prepayment rates rose to 24.99 per cent during Q1, up from 19.62 per cent in Q4 2022, reflecting the strong refinancing conditions for prime borrowers in the market as banks compete for prime-quality borrowers.

Ms Kitson noted lender competition is “likely to persist” until the large volume of loans that are due to roll off fixed rates onto variables rates is worked through for prime borrowers.

As such, competition among lenders will influence prepayment trends.

For example, the withdrawal of cashback offers and recent above cash rate rises by several lenders will dampen refinancing activity.

“This could be offset by the lowering of serviceability buffers by some lenders which will help keep up momentum in refinance activity,” Ms Kitson said.

However, prepayment rates are expected to ease as rising interest rates increase debt serviceability hurdles, constraining refinancing prospects for some borrowers.

For non-conforming prepayment rates, the report showed a 33.72 per cent fall in Q1 from 38.91 per cent in Q4 2022.

The decline reflects tougher refinancing conditions for this profile of borrowers, in addition to rising cost-of-living pressures, constraining borrowers’ ability to make additional mortgage repayments.

“Falling prepayment rates in the non-conforming sector reflect the increasing hurdles faced by borrowers trying to switch to a lower mortgage rate,” Ms Kitson said.

“Despite the difficult times ahead for some borrowers, we expect strong employment conditions and proactive efforts by lenders to work with affected borrowers to minimise any dislocation in mortgage markets and systemic risk.”

[Related: Drop in refinancing likely to be short-lived]