Household budgets, already under pressure from flat incomes, underemployment and rising mortgage rates, face further cost of living pressures with the latest hikes in power prices, as highlighted by the New Daily.
Power bills will soar by hundreds of dollars next month in east coast states, and experts blame policy uncertainty in Canberra.
Two major retailers, Energy Australia and AGL, have announced they will hike prices substantially from July 1. A third, Origin Energy, is expected to follow soon.
Energy Australia will increase power bills by almost 20 per cent, roughly $300 more a year, for households in South Australia and New South Wales. Gas prices will go up 9.3 per cent in NSW and 6.6 per cent in SA, adding between $50 and $80 to annual bills.
Queensland customers will be least affected, suffering only a 7.3 per cent ($130) increase to residential power bills. This is due mainly to the Palaszczuk government forcing the state government-owned distribution network to take a hit to profits.
A week earlier, AGL, the country’s third-biggest energy provider, said it would push up electricity by 16.1 per cent and gas by 9.3 per cent next month in NSW, QLD, SA and the ACT.
Victorians and Tasmanians have escaped bill shock for now, but only because their prices operate on a different schedule. Annual price changes in those states will be announced in December, kicking in on January 1.
Dylan McConnell, energy expert at Melbourne University, said years of policy uncertainty resulted in barely any new generators being built to replace the withdrawal of ageing coal and gas-fired power stations.
This has forced the National Energy Market (which supplies to NSW, QLD, SA, VIC, TAS and the ACT) to rely more heavily on expensive gas-fired generators to fill gaps in supply.
“We’ve had an effective ‘capital strike’, where policy uncertainty has resulted in a lack of investment and delays with respect to upgrades, maintenance and new installations – whether that’s new renewables, new storage, new anything – forcing us to rely on older, gas-fired technology,” Mr McConnell told The New Daily.
“At the same time we’ve had the gas market open up LNG exports, which has put substantial pressure on gas prices.
“These higher gas prices have flowed through to electricity prices, mainly because of the way the price-setting mechanism works in the wholesale market. Basically, gas is the marginal generator a lot of the time, and it’s actually become more of the marginal generator. That means the effect is more acute.”
If the sun stops shining on solar panels, the wind stops blowing on turbines and demand exceeds what traditional generators can supply, gas-fired turbine generators are fired up to plug the gap – at great expense to consumers.
Energy Australia and business groups have implored Canberra to embrace the recommendations of Chief Scientist Dr Alan Finkel, who published an energy policy review last week.
Energy Australia chief customer officer Kim Clarke said the Finkel review was a “good, solid blueprint” for Canberra to follow.
“A sensible next step is for governments to engage industry and other stakeholders on the Finkel package of reforms to discuss the best way forward,” Ms Clarke said in a statement.
The Finkel review confirmed that policy uncertainty has constrained the building of much-needed ‘dispatchable’ energy sources – that is, the kind of generators that can be switched on and off quickly to meet the increasingly more volatile energy usage habits of Australians.
“Uncertainty related to emissions reduction policy and how the electricity sector will be expected to contribute to future emissions reduction efforts has created a challenging investment environment,” Dr Finkel wrote.
In the absence of reliable power sources (which, Dr Finkel notes, could have included battery-stored solar and wind energy), generators have had to rely more heavily on gas turbines to create electricity, with the result that consumers pay more.
“Ageing generators are retiring from the NEM, but are not being replaced by comparable dispatchable capacity. Policy stability is required to give the electricity sector confidence to invest in the NEM.”
While Dr Finkel was at pains to say he was “technology neutral”, he predicted the future belonged to solar, wind and battery storage, not so-called lower-emission fossil fuels.
His main policy recommendation was his Clean Energy Target – effectively a watered-down carbon price – that would facilitate “an orderly transition to a low emissions future” and encourage investors to build new generators.
“It puts downward pressure on prices by bringing that new electricity generation into the market at lowest cost without prematurely displacing existing low-cost generators. It further ensures reliability by financially rewarding consumers for participating in demand response and distributed energy and storage.”
Dr Finkel’s report has sparked a war inside Coalition. Prime Minister Malcolm Turnbull and Energy Minister Josh Frydenberg are locked in a bitter debate with an estimated 20-25 anti-renewable Coalition MPs led by former prime minister Tony Abbott.
Other contributing factors to price hikes, noted by many experts, has been heavy investment in poles and wires, opportunistic price gouging by retailers, and the fact that many companies are both retailers and wholesalers (which has dried up liquidity for energy derivatives, especially in South Australia).
The Australian Law Reform Commission wants to give banks the responsibility to protect vulnerable customers from financial abuse. But there are a number of issues with this approach. Its success depends on the good faith of the banks, and could leave some customers uncovered and the banks with no one to report abuse to.
But the code is voluntary and some banks have been lax in the past, meaning some customers won’t be covered. “Reasonable steps” still needs to be defined, to ensure all banks meet a standard. And we need transparency to know what financial abuse banks are dealing with, how and when.
Around 9% of older people living in the community are financially abused. It is likely the number is even higher among those with cognitive impairment or who live in institutions. Financial exploitation of older people is increasing and mostly perpetrated by those close to the victim, including family members.
The amendments to the code will include measures such as enhanced staff training to recognise elder financial abuse, an obligation to report suspected abuse, and recommendations to tackle the problem of forced guarantees for mortgages and other loans to relatives.
Can the banks protect vulnerable people?
Elder financial abuse is difficult to detect. However, banks and financial institutions are in a unique position to see it. Banks have face-to-face contact with customers, play a role in providing third-party authorisations, monitor electronic transactions and oversee lending.
But the Code of Banking Practice is voluntary, and many in the industry are not signed on. This could lead to troubling gaps in coverage. Institutions that do not sign up to the code will be under no obligation at all.
Although some have imposed protocols to address elder financial abuse, a recent interview with Kirsty Mackie, chairwoman of the Elder Abuse Committee of the Queensland Law Society, noted that training of front-line banking staff, collaboration between institutions, understanding of the bank’s legal position, and preparedness to act in the customer’s best interest were all lacking.
The commission also settled on a standard that requires banks to take “reasonable steps” to prevent financial abuse, despite Legal Aid NSW recommending that a higher standard be adopted. The proposed alternative was to require banks to “take all steps” to prevent financial abuse.
A standard based on what is “reasonable” is problematic as context matters; what one bank may regard as a reasonable response to suspicions of elder abuse may differ from what a court or the general public thinks.
We need to know under what circumstances banks will keep matters “in house”, to decide if these are appropriate. Criteria for reporting suspected financial abuse need to be established, as well as a body to report to. The commission has recommended the implementation of an adult guardian to which complaints could be referred. All these issues remain unclear and will require more discussion.
A related concern is the potential ramifications for people who make reports. In Australia, whistle-blower protection remains inadequate. Indeed, the Australian Banking Association submission to the Australian Law Reform Commission suggested that immunity be granted to banks that report instances of elder financial abuse.
Finally, given that banks will deal internally with most instances of elder financial abuse, it is important that we ensure the bank’s response balances the autonomy of older people while addressing elder financial abuse.
Where to from here?
The commission recommendation is welcome and will bolster the safeguards already in place. More discussion will be needed in the aftermath of the inquiry to ensure the recommendations are implemented and their potential realised.
The reality is that success will rest largely on the good faith of the banks. There must be willingness to build a collaborative and consistent approach to acting on elder financial abuse and to ensure rigorous internal procedures are put in place and followed. Employees who make reports of elder abuse must also have adequate protection.
This, in turn, must feed into an appropriately resourced entity where the most serious matters can be directed.
Author: Eileen Webb, Associate Professor, Curtin Law School, Curtin University
No sign of a change in trajectory, despite low wage growth and some lending tightening. The last available data point on household debt to income is 188.7 from December 2016. The March data should be out soon and will be higher again.
Of course this is an average, and some households are in deep debt strife, right now, as higher mortgage rates hit. See our latest mortgage stress analysis released a couple of days ago.
Digital Finance Analytics has released mortgage stress and default modelling for Australian mortgage borrowers, to end May 2017. Across the nation, more than 794,000 households are now in mortgage stress (last month 767,000) with 30,000 of these in severe stress. This equates to 24.8% of households, up from 23.4% last month. We also estimate that nearly 55,000 households risk default in the next 12 months.
The main drivers are rising mortgage rates and living costs whilst real incomes continue to fall and underemployment is on the rise. This is a deadly combination and is touching households across the country, not just in the mortgage belts.
This analysis uses our core market model which combines information from our 52,000 household surveys, public data from the RBA, ABS and APRA; and private data from lenders and aggregators. The data is current to end May 2017.
We analyse household cash flow based on real incomes, outgoings and mortgage repayments. Households are “stressed” when income does not cover ongoing costs, rather than identifying a set proportion of income, (such as 30%) going on the mortgage.
Those households in mild stress have little leeway in their cash flows, whereas those in severe stress are unable to meet repayments from current income. In both cases, households manage this deficit by cutting back on spending, putting more on credit cards and seeking to refinance, restructure or sell their home. Those in severe stress are more likely to be seeking hardship assistance and are often forced to sell.
Martin North, Principal of Digital Finance Analytics said “Mortgage stress continues to rise as households experience rising living costs, higher mortgage rates and flat incomes. Risk of default is rising in areas of the country where underemployment, and unemployment are also rising. Expected future mortgage rate rises will add further pressure on households”.
“Stressed households are less likely to spend at the shops, which acts as a drag anchor on future growth. The number of households impacted are economically significant, especially as household debt continues to climb to new record levels. The latest housing debt to income ratio is at a record 188.7* so households will remain under pressure.”
“Analysis across our household segments highlights that stress is touching more affluent groups as well as those in traditional mortgage belts”.
*RBA E2 Household Finances – Selected Ratios Dec 2016.
Regional analysis shows that NSW has 216,836 (211,000 last month) households in stress, VIC 217,000 (209,000), QLD 145,970 (139,000) and WA 119,690 (109,000). The probability of default has also risen, with more than 10,000 in WA, 10,000 in QLD, 13,000 in VIC and 15,000 in NSW.
Probability of default extends the mortgage stress analysis by overlaying economic indicators such as employment, future wage growth and cpi changes. Regional analysis is included in the table below.
There were a number of familiar themes in Secretary to the Treasury John Fraser’s opening address to budget estimates. But the section on household finances bears close reading. He says developments in the housing market will remain a key risk to the outlook and the near term the outlook for wage growth remains subdued, reflecting spare capacity in the labour market.
Household consumption has grown in recent years, but below historical rates with average growth in consumption per capita of just 1.1 per cent since the GFC.
This partly reflects weak per capita income growth over this period.
Consumption accounts for around 60 per cent of GDP and almost half of GDP growth so it is a critical factor in determining the strength of the economy.
We expect household consumption to pick up over the forecast horizon and continue to grow by more than household income, as labour market conditions improve and wages growth picks up. This would result in a further decline in the household saving rate.
Still, there are risks to the real economy around the momentum in household consumption – in particular, a change in households’ attitudes toward saving could lead to household consumption being weaker than forecast.
Wage growth has recently been low by historical standards, with the wage price index growing by 1.9 per cent through the year to March 2017.
We expect wages growth to increase as domestic demand strengthens, but in the near term the outlook for wage growth remains subdued, reflecting spare capacity in the labour market.
The near term outlook for inflation is also subdued.
Although full-time employment has strengthened recently, labour market conditions have generally softened after strong employment growth in 2015, with the majority of employment increases over the last 18 months being been in part time employment.
All that said, the unemployment rate remains below 6 per cent and indicators such as job advertisements, vacancies and business survey measures suggest labour market conditions will improve.
Employment is forecast to grow by one and half per cent through the year to the June quarters of 2018 and 2019 and the unemployment rate is forecast to decline modestly through the forecast period – consistent with an improving outlook for business and the economy overall.
Housing and dwelling investment
Household balance sheets have been strengthened by a notable rise in the value of housing and superannuation assets since the GFC, with household assets now more than five times higher than household debt.
We should be mindful that household debt has grown more rapidly than incomes in recent years, driven in particular by increasing levels of housing debt.
Dwelling prices have increased by 16 per cent through the year in Sydney and 15.3 per cent in Melbourne, though there have been some recent indications that this growth is moderating.
It is also important to emphasise that in other cities and regions, prices have been growing more moderately or declining for some years.
There are a number of complex factors that drive the housing market across both the demand side and the supply side.
For instance, there is no doubt that low interest rates have combined with population growth along the east coast to increase demand and support greater dwelling investment.
At the same time, insufficient land release, complex planning and zoning regulations and public aversion to urban infill have impacted the supply of housing.
Residential construction activity was subdued in the mid‑to-late 2000s leading to a state of pent-up demand in the housing market.
But activity has strengthened since 2012 with significant investment in medium-to-high density dwellings.
As the current pipeline of dwelling construction reaches completion over the next two years it is likely that dwelling investment will ease as a share of the economy.
Developments in the housing market will remain a key risk to the outlook, and the Treasury and our regulatory counterparts will be paying close attention to adjustments in the market.
As the steps taken recently by the Australian Prudential Regulation Authority demonstrate, there is a role for sensible and careful measures that can address risks and underpin market stability – and we will continue to focus on these going forward
RBA Governor Philip Lowe spoke at the Economic Society of Australia (QLD) Business Lunch. Of note is the data which shows one third of households with a mortgage have little or no interest rate buffer, and that the Reserve Bank does not have a target for the debt-to-income ratio or the ratio of nationwide housing prices to income.
This afternoon I would like to talk about household debt and housing prices.
This is a familiar topic and one that has attracted a lot of attention over recent times. It is understandable why this is so. The cost of housing and how we finance it matters to us all. We all need somewhere to live and for many people, their home is their largest single asset. Real estate is also the major form of collateral for bank lending. The levels of debt and housing prices also affect the resilience of our economy to future shocks. Beyond these economic effects, high levels of debt and housing prices have broader effects on the communities in which we live. The high cost of housing is a real issue for many Australians and can have serious side-effects. High levels of debt and high housing costs can also reinforce the existing distribution of wealth in our society, making social and geographic mobility more difficult. So it is understandable why Australians are so interested in these issues.
At the Reserve Bank, we too have been focused on these issues in the context of our monetary policy and financial stability responsibilities. Our work has been in three broad areas. First, understanding the aggregate trends and their causes. Second, understanding how debt is distributed across the community. And third, understanding how the level of debt and housing prices affect the way the economy operates and its resilience to future shocks.
This afternoon, I would like to make some observations in each of these three areas.
This first chart provides a good summary of the aggregate picture (Graph 1). It shows the ratios of nationwide housing prices and household debt to household income. Housing prices and debt both rose a lot from the mid 1990s to the early 2000s. The ratios then moved sideways for the better part of a decade – in some years they were up and in others they were down. Then, in the past few years, these ratios have been rising again. Both are now at record highs.
Although the debt-to-income ratio has increased over recent times, the ratio of debt to the value of the housing stock has not risen. This reflects the large increase in housing prices and the growth in the number of homes. Over recent times, there has also been a substantial increase in the value of households’ financial assets, with the result that the ratio of household wealth to income is at a record high (Graph 2). So both the value of our assets and the value of our liabilities have increased relative to our incomes.
Turning now to why the ratios of housing prices and debt to income have risen over time. A central factor is that financial liberalisation and the lower nominal interest rates that came with the lower inflation of the 1990s increased people’s ability to borrow. These developments meant that Australians could take out larger and more flexible loans. By and large, we took advantage of this new ability, as we sought to buy the housing we desired.
We could, of course, have used the benefit of lower nominal interest rates in the 1990s and the increased ability to borrow for other purposes. But instead we chose to borrow more for housing and this pushed up the average price of housing given the constraints on the supply side. The supply of well-located housing and land in our cities has been constrained by a combination of zoning issues, geography and inadequate transport. Another related factor was that our population was growing at a reasonable pace. Adding to the picture, Australians consume more land per dwelling than is possible in many other countries, although this is changing, and many of us have chosen to live in a few large coastal cities. Increased ability to borrow, more demand and constrained supply meant higher prices.
So we saw marked increases in the ratios of housing prices and debt to household incomes up until the early 2000s. At the time, there was much discussion as to whether these higher ratios were sustainable. As things turned out, the higher ratios have been sustained for quite a while. This largely reflects the choices we have made as a society regarding where and how we live (and how much at least some of us are prepared to spend to do so), urban planning and transport, and the nature of our financial system. It is these choices that have underpinned the high level of housing prices. So the changes that we have seen in these ratios are largely structural.
Recently, the ratios of housing prices and debt to household income have been increasing again. Lower interest rates both in real and nominal terms – this time, largely reflecting global developments – have again played some role. But there have also been other important factors at work over recent times.
One of these is the slow growth in household income. During the 2000s, aggregate household income increased at an average rate of over 7 per cent (Graph 3). In contrast, over the past four years growth has averaged less than half of this, at about 3 per cent. Slower growth in incomes will push up the debt-to-income ratio unless growth in debt also slows. This partly explains what has happened over recent years.
A second factor is that some of our cities have become major global cities. Reflecting this, in some markets there has been strong demand by overseas investors.
A third factor has been stronger population growth. Population growth picked up during the mining investment boom and, although it subsequently slowed, it is still around ½ percentage point faster than it was before the boom (Graph 4). For some time the rate of home-building did not respond to the faster population growth; indeed, the response took the better part of a decade. The rate of home-building has now responded and we are currently adding to the housing stock at a rate not seen for more than two decades. Over time, this will make a difference.
It is Melbourne and Sydney where population growth has been the fastest over recent times. Not surprisingly, it is these two cities where the price gains have been largest, and these price gains have helped induce more supply. Indeed, Victoria and New South Wales account for all of the recent upward movement in the national housing price-to-income ratio (Graph 5). In the other states, the ratio of housing prices to income is below previous peaks. So there is not a single story across the country. This is despite us having a common monetary policy for the country as a whole. Factors other than the level of interest rates are clearly at work.
In summary then, the supply-demand dynamics have been pushing aggregate housing prices in our largest cities higher relative to our incomes. With interest rates as low as they have been, and prices rising, many people have found it attractive to borrow money to invest in an asset whose price is increasing. The result has been strong growth in borrowing by investors, with investors accounting for 30 to 40 per cent of new loans.
This borrowing is not the underlying cause of the higher housing prices. But the borrowing has added to the upward pressure on prices caused by the underlying supply-demand dynamics. It has acted as a financial amplifier in some cities, adding to the already upward pressure on prices. The borrowing by investors is also obviously contributing to the rise in the aggregate debt-to-income ratio. Just like in the early 2000s, there is again a discussion as to whether these increases will continue and whether they are sustainable.
The Distribution of Debt
I would now like to turn to the distribution of housing debt across households. This is important, as it is not the ‘average’ household that gets into trouble. At the Reserve Bank we have devoted considerable resources to understanding this distribution. One important source of household-level information is the survey of Household Income and Labour Dynamics in Australia (HILDA).
If we look across the income distribution, it is clear that the rise in the debt-to-income ratio has been most pronounced for higher-income households (Graph 6). This is different from what occurred in the United States in the run-up to the subprime crisis, when many lower-income households borrowed a lot of money.
It is also possible to look at how the debt-to-income ratio has changed across the age distribution. This ratio has risen for households of all ages, except the very youngest, who tend to have low levels of debt (Graph 7). Borrowers of all ages have taken out larger mortgages relative to their incomes and they are taking longer to pay them off. Older households are also more likely than before to have an investment property with a mortgage and it has become more common to have a mortgage at the time of retirement.
We also look at the share of households with a debt-to-income ratio above specific thresholds. In 2002, around 12 per cent of households had debt that was over three times their income (Graph 8). By 2014, this figure had increased to 20 per cent of households. There has also been an increase, although not as pronounced, in the share of households with even higher debt-to-income ratios.
Another dataset that provides insight into distributional issues is one maintained by the Reserve Bank on loans that have been securitised. This indicates that around two-thirds of housing borrowers are at least one month ahead of their scheduled repayments and half of borrowers are six months or more ahead (Graph 9). This is good news. But a substantial number of borrowers have only small buffers if things go wrong.
At the overall level, though, nationwide indicators of household financial stress remain contained. This is not surprising with many borrowers materially ahead on their mortgage repayments, interest rates being low and the unemployment rate being broadly steady over recent years. At the same time, though, the household-level data show that there has been a fairly broad-based increase in indebtedness across the population and the number of highly indebted households has increased.
Impact on Economy and Policy Considerations
I would now like to turn to the third element of our work: the implications of all this for the way the economy operates and its resilience.
It is now commonplace to say that housing prices and debt levels matter because of financial stability. What people typically have in mind is that a severe correction in property prices when balance sheets are highly leveraged could make for instability in the banking system, damaging the economy. So the traditional financial stability concern is that the banks get in trouble and this causes trouble for the overall economy.
This is not what lies behind the Reserve Bank’s recent focus on household debt and housing prices in Australia. The Australian banks are resilient and they are soundly capitalised. A significant correction in the property market would, no doubt, affect their profitability. But the stress tests that have been done under APRA’s eye confirm that the banks are resilient to large movements in the price of residential property.
Instead, the issue we have focused on is the possibility of future sharp cuts in household spending because of stretched balance sheets. Given the high levels of debt and housing prices, relative to incomes, it is likely that some households respond to a future shock to income or housing prices by deciding that they have borrowed too much. This could prompt a sharp contraction in their spending, as they try to get their balance sheets back into better shape. An otherwise manageable downturn could be turned into something more serious. So the financial stability question is: to what extent does the higher level of household debt make us less resilient to future shocks?
Answering this question with precision is difficult. History does not provide a particularly good guide, given that housing prices and debt relative to income are at levels that we have not seen before, and the distribution of debt across the population is changing.
Given this, one of the research priorities at the Reserve Bank has been to use individual household data to understand better how the level of indebtedness affects household spending. The results indicate that the higher is indebtedness, the greater is the sensitivity of spending to shocks to income. This is regardless of whether we measure indebtedness by the debt-to-income ratio or the share of income spent on servicing the debt. If this result were to translate to the aggregate level, it would mean that higher levels of debt increase the sensitivity of future consumer spending to certain shocks.
The higher debt levels also appear to have affected how higher housing prices influence household spending. For some years, households used the increasing equity in their homes to finance extra spending. Today, the reaction seems different. This is evident in the estimates of housing equity injection (Graph 10). In earlier periods of rising housing prices, the household sector was withdrawing equity from their housing to finance spending. Today, households are much less inclined to do this. Many of us feel that we have enough debt and don’t want to increase consumption using borrowed money. Many also worry about the impact of higher housing prices on the future cost of housing for their children. As I have spoken about previously, higher housing prices are a two-edged sword. They deliver capital gains for the current owners, but increase the cost of future housing services, including for our children.
This change in attitude is also affecting how spending responds to lower interest rates. With less appetite to incur more debt for current consumption, this part of the monetary transmission mechanism looks to be weaker than it once was. There is, however, likely to be an asymmetry here. When the interest rate cycle turns and rates begin to rise, the higher debt levels are likely to make spending more responsive to interest rates than was the case in the past. This is something that we will need to take into account.
In terms of resilience, my overall assessment is that the recent increase in household debt relative to our incomes has made the economy less resilient to future shocks. Given this assessment, the Reserve Bank has strongly supported the prudential measures undertaken by APRA. Double-digit growth in debt owed by investors at a time of weak income growth cannot be strengthening the resilience of our economy. Nor can a high concentration of interest-only loans.
I want to point out that APRA’s measures are not targeted at high housing prices. The international evidence is that these types of measures cannot sustainably address pressures on housing prices originating from the underlying supply-demand balance. But they can provide some breathing space while the underlying issues are addressed. In doing so, they can help lessen the financial amplification of the cycle that I spoke about before. Reducing this amplification while a better balance is established between supply and demand in the housing market can help with the resilience of our economy.
There are some reasons to expect that a better balance between supply and demand will be established over time.
One is the increased rate of home-building. As we are seeing here in Brisbane and some parts of Melbourne, increased supply does affect prices. This increase in supply is also affecting rents, which are increasing very slowly in most markets.
A second reason is the increased investment in some cities, including in Sydney, on transport. Over time, this will increase the supply of well-located residential land, and this will help as well.
And a third reason is that at some point, interest rates in Australia will increase. To be clear, this is not a signal about the near-term outlook for interest rates in Australia but rather a reminder that over time we could expect interest rates to rise, not least because of global developments. Over recent years, the low interest rates in Australia have helped the economy adjust to the winding down of the mining investment boom. They have helped support employment and demand through a significant adjustment in the Australian economy. We should not, though, expect interest rates always to be this low.
It remains to be seen how the various influences on housing prices play out. Other policies, including tax and zoning policies, also have an effect. But increased supply and better transport could be expected to help address the ongoing rises in housing prices relative to incomes. These changes and some normalisation of interest rates over time might also reduce the incentive to borrow to invest in an asset whose price is rising strongly. To the extent that, over time, a better balance is established, we will be better off not incurring too much debt, and having housing prices go too high, while this is occurring.
I want to make it clear that the Reserve Bank does not have a target for the debt-to-income ratio or the ratio of nationwide housing prices to income.
As I spoke about earlier, there are good reasons why these ratios move over time. My judgement, though, is that, in the current environment, the resilience of our economy would be enhanced by an extended period in which housing prices and debt outstanding increased no faster than our incomes. Again, this is not a target or a policy objective of the Reserve Bank, but rather a general observation about how we build resilience.
Many of you will be aware that these issues have figured in the deliberations of the Reserve Bank Board for some time. This is entirely consistent with our flexible medium-term inflation targeting framework. With a medium-term target, it is appropriate that we pay attention to the resilience of our economy to future shocks. In the current environment of low income growth, faster growth in household debt is unlikely to help that resilience.
We have also been watching the labour market closely. The unemployment rate has moved up a little over recent months and wage growth remains subdued. Encouragingly, employment growth has been a bit stronger of late and the forward-looking indicators suggest ongoing growth in employment. We will want to see a continuation of these trends if the overall growth in the economy is to pick up as we expect. Stronger growth in incomes would of course also help people deal with the high levels of debt and housing prices. Overall, our latest forecast is for economic growth to pick up gradually and average around 3 per cent or so over the next few years.
To conclude, I hope these remarks help provide some insight into the Reserve Bank’s thinking about housing prices and household debt. As household balance sheets have changed, so too has the way that the economy works. Both from an individual and an economy-wide perspective, we need to pay attention to how the higher level of debt affects our resilience to future shocks.
The RBA released their May 2017 chart pack. We once again went straight to the household finances section, and as expected the debt to income ratio has deteriorated further. More debt means more stress, all else being equal. And with rates rising… etc … you know the rest!
The burden of housing costs is biting even in Australia’s wealthiest suburbs as an unprecedented one in four households nationally face mortgage stress, according to the latest in a 15-year series of analyses.
Households in Toorak and Bondi, prestigious pockets of affluence in Australia’s biggest cities, have made the list of those struggling to meet repayments amid rising costs and stagnating wages, research firm Digital Finance Analytics has found.
The firm’s principal, Martin North, said it was surprising new evidence showed that financial distress from property price surges reached beyond “the battlers and the mortgage belt” and was a “much broader and much more significant problem”.
The survey, which analyses real cash flows against mortgage repayments, finds more than 767,000 households or 23.4% are now in mortgage stress, which means they have little or no spare cash after covering costs.
This includes 32,000 that are in severe stress, meaning they cannot cover repayments from current income.
The firm predicts that almost 52,000 households will probably default on mortgages over the next year. Risk hotspots include Meadow Springs and Canning Vale in Western Australia, Derrimut and Cranbourne in Victoria, and Mackay and Pacific Pines in Queensland.
Overall, New South Wales and Victoria, whose capital cities have seen a recent surge in home prices, accounted for more than half the probable defaults (270,000) and households in mortgage distress (420,000).
North said the numbers were “an early indicator of risk in the system”.
The underlying drivers were “flat or falling wage growth”, much faster rising living costs and the likelihood mortgage interest payments would only go up.
Widespread mortgage burdens were limiting spending elsewhere and “sucking the life out of the economy”, and the problem should be addressed to head off a housing crash and its repercussions, North said.
“If we start seeing house prices slipping then this can turn into a US 2007 scenario rather quickly,” he said.
North is not alone in highlighting household vulnerability. The Reserve Bank of Australia’s financial stability review last month observed one-third of Australian borrowers had little or no mortgage “buffer”, which North said was “the first time they’ve ever admitted it”.
“The surprising thing is that people in Bondi in NSW, for example, or even young affluents who have bought down in Toorak in Victoria are actually on the list [of mortgage stressed],” North said.
“The reason is they’ve bought significantly large mortgages to buy a unit, modified or brand new.
“They’ve got bigger incomes than average but essentially they are highly leveraged so they have little wiggle room and of course any incremental rate rise, because they’ve got such big mortgages, slugs them pretty heavily.”
Semi-retirees who moved to central coast NSW but are still exposed to large mortgages while their incomes were falling away were another atypical snapshot of those in financial distress, North said.
“And the people at the top, the most affluent households, the ones who’ve got really big properties, have the lifestyles to match. So again, their spare cash is not huge.
“And that point – it isn’t just the mortgage belt, it isn’t just the typical battlers who are actually exposed here – shows is a much broader, more significant problem.”
Mortgage brokers have an important role to play for the increasing number of households experiencing mortgage stress, as they are a “very good source of advice” according to a market analyst.
Around 52,000 households are now at risk of default in the next 12 months, according to mortgage stress and default modelling from Digital Finance Analytics for the month of April.
The modelling revealed that across the nation, more than 767,000 households are now in mortgage stress (669,000 in March) with 32,000 of those in ‘severe’ stress. Overall, this equates to 23.4 per cent of households, up from 21.8 per cent on the prior month.
Speaking to Mortgage Business, Digital Finance Analytics principal Martin North remarked that mortgage brokers have a role to play for stressed households in terms of helping them “find their way through the maze”.
“Maybe that’s a restructure, maybe it’s a different type of loan… I think [brokers] are a very good source of advice for households and for people who come and seek guidance [for example] refinancing may help,” Mr North said.
In saying this, Mr North noted that when it comes to identifying an appropriate loan for customers, brokers should remain “conservative” in their estimation of what households can afford.
“Don’t encourage households to borrow as big as they can. That 2 to 3 per cent buffer is really important, and those spending and affordability calculations are really important.
“There’s an obligation both on brokers and on lenders to do due diligence on borrowers to make sure that they’re not buying unsuitably, and that includes detailed analysis of household expenditure.
“My observation is that some of those calculations don’t necessarily get to the real richness of where households are at, so I think that all those operating in the market need to be aware of the fact that how we look at spending becomes really important on mortgage assessments.”
Mr North added that brokers should operate on the assumption that rates and the cost of living will continue to rise, while incomes remain static.
“So, don’t try and flog that bigger mortgage,” he recommended. “I would say be conservative in your advice and the structure of the conversation you have.”
The latest results of Digital Finance Analytics’ mortgage stress and default modelling are “not all that surprising”, Mr North said, considering that incomes are static or falling, mortgage rates are rising, and the cost of living remains “very significant” for many households.
“All those things together mean that we’ve got a bit of a perfect storm in terms of creating a problem for many households,” he said, adding that for many households, any further rises in mortgage rates or the cost of living would be sufficient to move them from ‘mild’ to ‘severe’ stress.
“It doesn’t take much to tip people over the edge. It takes about 18 months to two years between people getting into financial difficulty and ultimately having to refinance or sell their property or do something to alleviate it dramatically, so I think we’re in that transition period at the moment as rates rise… over the next 12 to 18 months my expectation is that we would see mortgage stress and defaults both on the up.”
According to Mr North, Digital Finance Analytics’ data uses a core market model, which combines information from its 52,000 household surveys, public data from the RBA, ABS and APRA, and private data from lenders and aggregators. The data is current to the end of April 2017.
The market analyst examines household cash flow based on real incomes, outgoings and mortgage repayments. Households are “stressed” when income does not cover ongoing costs, rather than identifying a set proportion of income, (such as 30 per cent) directed to a mortgage.
By way of background, we have been tracking stress for years, and in 2014 we set out the approach we use. Other than increasing the sample, and getting more granular on household finance, the method remains the same, and consistent. We can plot the movement of stress over time.
For this analysis we plot the number of households in mild stress (making mortgage repayments on time but tightening their belts so to do); severe stress (insufficient cash flow to pay the mortgage), and also an estimation of the number of households who may hit a 30-day default within the next 12 months. This is calculated by adding in a range of economic overlays into the stress data. This is all done in our core market model, which contains data from our rolling surveys, private data from lenders and other sources, and public data from the RBA, APRA and ABS. This model is unique in the Australian context because it runs at a post code and household segment level, allowing us to drill into the detail. This is important because averaging masks significant variations.
The analysis shows that there are more severely stressed households in NSW than other states, and that around 13,000 households risk default in the next year, a similar number to VIC. WA is third on this list, with the number of defaults lower elsewhere.
Another lens is by the locations of households, in the residential zones around our major cities. The highest risk of default resides in the our suburbs, where a higher proportion of households are in severe stress. Households in inner regional Australia are next, followed by the inner suburbs, where again more households are in severe stress.
Our core household segmentation shows that the highest count of defaults are likely among the suburban mainstream, then the disadvantaged fringe, followed by mature stable families and young growing families. It is also worth noting that the young affluent and exclusive professional, the two most affluent segments contain a number of severe stressed households. This have larger mortgages and lifestyles, but not necessarily more available cash.
Finally, for today, here is the mapping across the regions. No surprise that the largest number of stressed households are in the main urban centres of Melbourne and Sydney.
Next time we will look at post codes across the country.