One in five homeowners will struggle with rate rise of less than 0.5%

From News.com.au

ONE in five Australians are walking such a fine mortgage tightrope that they could lose their homes if interest rates rise by even 0.5 per cent.

Our love affair with property has pushed Australia’s residential housing market to an eye-watering value of $6.2 trillion.

But as we scramble over each other to snap up property while interest rates are at historic lows, we have gotten ourselves into a bit of a pickle. We might not actually be able to afford funding our affair.

An analysis, based on extensive surveys of 26,000 Australian households, compiled by Digital Finance Analytics, examined how much headroom households have to rising rates, taking account of their income, size of mortgage, whether they have paid ahead, and other financial commitments. And the results are distressing.

It showed that around 20 per cent — that’s one in five homeowners — would find themselves in mortgage difficulty if interest rates rose by 0.5 per cent or less. An additional 4 per cent would be troubled by a rise between 0.5 per cent and one per cent.

Almost half of homeowners (42 per cent) would find themselves under financial pressure if home loan interest rates were to increase from their average of 4.5 per cent today to the long term average of 7 per cent.

“This is important because we now expect mortgage rates to rise over the next few months, as higher funding costs and competitive dynamics come into pay, and as regulators bear down on lending standards,” Digital Finance Analytics wrote.

The major banks have already started increasing their home loan rates this year, despite the market broadly expecting the Reserve Bank to keep the cash rate steady at 1.5 per cent this year.

Just this week NAB upped a number of its owner-occupied and investment fixed rate loans.

“There are a range of factors that influence the funding that NAB — and all Australian banks — source, so we can provide home loans to our customers,” NAB Chief Operating Officer, Antony Cahill, said of the announcement.

“The cost of providing our fixed rate home loans has increased over recent months.”

So as interest rates rise and leave mortgage holders in its dust, it leaves a huge section of society, and our economy, exposed and at risk.

NOT TERRIBLY SURPRISING

Martin North, Principal of Digital Finance Analytics, said the results are concerning, albeit not surprising.

“If you look at what people have been doing, people have been buying into property because they really believe that it is the best investment. Property prices are rising and interest rates are very low, which means they are prepared to stretch as far as they can to get into the market,” Mr North told news.com.au.

But the widespread assumption that interest rates will remain at historic lows is a disaster waiting to happen, especially in an environment where wage growth is stagnant.

“If you go back to 2005, before the GFC, people got out of jail because their incomes grew a lot faster than house prices, and therefore mortgage costs. But the trouble is that this time around we are not seeing any evidence of real momentum in income growth,” Mr North said.

“My concern is a lot of households are quite close to the edge now — they are not going to get out of jail because their incomes are going to rise. We are in a situation where interest rates are likely to rise irrespective of what the RBA does … There has already been movement up.”

Australia’s wages grew at the slowest pace on record in the three months to September 2016, according to the latest Wage Price Index released by the Australian Bureau of Statistics (ABS).

And as a result Australia’s debt-to-income ratio is astronomical. The ratio of household debt to disposable income has almost tripled since 1988, from 64 per cent to 185 per cent, according to the latest AMP. NATSEM Income and Wealth report.

What this means is that many Australian households are highly indebted, thanks in large part to the property market, without the income growth to pay it down.

“The ratio of debt to income is as high as it’s ever been in Australia and there are some households that are very, very exposed,” Mr North said.

THE YOUNG AND RICH MOST AT RISK

This finding will come as a surprise: young affluent homeowners are the most at risk — it is not just a problem with struggling families on the urban fringe. When it comes to this segment of the market, around 70 per cent would be in difficulty with a 0.5 per cent or less rise. If rates were to hike 3 per cent, bringing them to around the long term average of 7 per cent, nine in ten young affluent homeowners would feel the pressure.

“It is not necessarily the ones you think would be caught. And that’s because they are actually more able to get the bigger mortgage because they’ve got the bigger income to support it.

“They have actually extended themselves very significantly to get that mortgage — they have bought in an area where the property prices are high, they have got a bigger mortgage, they have got a higher LVR [loan-to-valuation ratio] mortgage and they have also got lot of other commitments. They are usually the ones with high credit card debts and a lifestyle that is relatively affluent. They are not used to handling tight budgets and watching every dollar.”

And while the younger wealthy segment of the market being most at risk might not be of that much importance compared to other segments, Mr North said what is concerning is the intense focus on this market.

“Any household group that is under pressure is a problem for the broader economy because if these people are under pressure they are not going to be spending money on retail and the broader economy,” Mr North told news.com.au.

“The banks tend to focus in on what they feel are the lower risk segments and the young affluent sector has actually been quite a target for the lending community in the last 18 months. Be that investment properties or first time owner-occupied properties, my point is there is more risk in that particular sector than perhaps the industry recognises.”

TOUGHER HOME LOAN RESTRICTIONS NEEDED

Now an argument is mounting that Australian banks need to toughen up their approach to home lending.

“I think we have got a situation where the information that is being captured by the lenders is still not robust enough. I am seeing quite often lenders willing to lend what I would regard as relatively sporty bets … I’m questioning whether the underwriting standards are tight enough,” Mr North said.

This includes accepting financial help from relatives for a deposit, a growing trend among first home buyers.

“The other thing that I have discovered in my default analysis is that those who have got help from the ‘Bank of Mum and Dad’ to buy their first property are nearly twice as likely to end up in difficulty … It potentially opens them to more risk later because they haven’t had the discipline of saving.”

News.com.au contacted several banks for comment on whether they think a rethink of their underwriting standards is needed. Only one lender, Commonwealth Bank, agreed to comment, but remained vague on the topic.

“In line with our responsible lending commitments, we constantly review and monitor our loan portfolio to ensure we are maintaining our prudent lending standards and meeting our customers’ financial needs. Buffers and minimum floor rates are used when assessing loan serviceability so it is affordable for customers,” a CBA spokesman said in an emailed statement.

But Mr North said something needs to be done before we find ourselves in a property and economic downturn.

“I’m assuming that with the capital growth we have seen in the property market, it will allow people who get into significant difficulty to be able to get out, however, it’s the feedback concern that I’ve got.

“If you have got a lot of people in the one area struggling with the same situation, you might see property prices begin to slip. If we get the property price slip, and we get unemployment rising and interest rates rising at the same time, we have that perfect storm which would create quite a significant wave of difficulty.

“We need to be thinking now about how to deal with higher interest rates down the track. We can’t just say it will be fine because it won’t be,” he told news.com.au.

The Definitive Guide To Our Latest Mortgage Stress Research

We have had an avalanche of requests for further information on our recent research which was published as a series of blog posts over the past couple of weeks. Here is a summary of the findings.

In addition, here is a list of links to each segment, which together provides a comprehensive view of the work. This will all be rolled up into our next Property Imperative Report, to be published in a couple  of months.

Note that a number of people went to our 2015 report – The Stressed Household Finance Landscape, which looks at households and their use of small amount credit contracts, a.k.a. payday lending. This is a separate stream of work.

So here are all the links to each element of the mortgage stress and probability of default analysis, with a short summary and publication date.

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A Segmented View Of Mortgage Stress and Default

As we continue our series on mortgage stress, using the latest data from our surveys, we look at how stress aligns with our core household and property owning segments. To set the context for this, here are a couple of charts showing the mortgage distribution by income and age bands. The majority of mortgages are

Posted on December 19, 2016

Top 20 Postcodes For Mortgage Stress Across Australia

Now we get to the pointy end of our mortgage stress and default analysis. Today we list the top 20 post codes across Australia where the highest number of households currently in mortgage stress reside. We also reveal our estimate for the number of defaults which we expect to occur in the coming months. It …

Posted on December 20, 2016

New DFA Video Blog – Household Mortgage Stress and Defaults

Using data from our household surveys in this new video blog we discuss the findings from our latest modelling. More than 22% of households are currently in mortgage stress, and 1.9% of households are likely to default. Both are likely to rise next year.

Posted on December 20, 2016

The Full 100 Mortgage Stress Listing

To complete our series on mortgage stress, based on our household surveys, here is the complete list of the top 100 most stressed suburbs, and their relative position on the default list, as at December 2016. Victoria has the highest number of suburbs in the listing. As we discussed yesterday, this is based on the …

December 21, 2016

Mortgage Default Heat Map Predictions

In our last post for 2016 we have geo-mapped the probability of mortgage default by post code across the main urban centres through 2017. You can read about our approach to the analysis here. We start with Sydney, which is looking pretty comfortable. Melbourne is also looking reasonable, though with a few hot spots. Brisbane …

Posted on December 31, 2016

Channel Nine News Does House Prices and Mortgage Defaults

A segment today from Channel Nine featured the latest data on Sydney residential property, and featured data from the Digital Finance Analytics mortgage default heat mapping, as well as the latest from CoreLogic on Home Prices.

Posted on January 3, 2017

Affluent suburbs feel heat from rising property costs

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Posted on January 9, 2017

ABC News 24 Does Affluent Mortgage Stress

Here is a segment in which we discuss our latest research into the probability of default modelling in a rising interest rate environment.  We highlight the rise of the “Affluent Stressed” households.

Posted on January 9, 2017

A Cumulative View Of Mortgage Rate Sensitivity

We had significant interest in our recent posts on mortgage rate sensitivity in a rising market. One recurring request was for a cumulative view of rate sensitivity. So today we post these views on a segmented basis, using our master household segmentation.

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One in five homeowners will struggle with rate rise of less than 0.5%

From News.com.au. ONE in five Australians are walking such a fine mortgage tightrope that they could lose their homes if interest rates rise by even 0.5 per cent. Our love affair with property has pushed Australia’s residential housing market to an eye-watering value of $6.2 trillion.

Posted on January 18, 2017

Home loan rates heading higher as funding costs rise, competition eases

From The Australian Financial Review. Mortgage rates are set to rise for both fixed and variable rate borrowers this year as global interest rates shoot higher, competition eases and capital rules begin to bite. “Borrowers should assume we are at the bottom of the interest rate cycle – in fact we are probably already past … Continue reading “Home loan rates heading higher as funding costs rise, competition eases”

Posted on 18 January 2017

ABC News 24 Does Household Mortgage Rate Sensitivity

We discussed the mortgage  rate sensitivity analysis we recently completed on News 24 tonight.

Posted on 18 January 2017

Check out our extensive recent media coverage.

 

ABC News 24 Does Affluent Mortgage Stress

Here is a segment in which we discuss our latest research into the probability of default modelling in a rising interest rate environment.  We highlight the rise of the “Affluent Stressed” households.

For those wanting to read more on our research, this is a link is to a list of all the recent analysis we completed.

Affluent suburbs feel heat from rising property costs

The Australian Financial Review featured the Digital Finance Analytics probability of default modelling today. We discussed our analysis on the blog recently.

Property buyers in some of the nation’s swankiest suburbs are among those under most stress keeping up mortgage repayments, according to an analysis by postcode of income and debt levels.

The young affluent in plush inner suburbs living the high life are more likely to be financially derailed by rising costs than battlers in new estates on the suburban outer fringes, the analysis reveals.

Households in Melbourne’s gilt-edged Toorak, about 8 kilometres south-east of the central business district, where median house prices are $3.5m and $845,000 for apartments, are five times more likely to default on mortgage payments than the national average.

It’s the same probability in Bondi, about 8 kilometres south-west of the central business district, where median prices are about $2.5m for a house and $1m for an apartment.

 

Other suburbs on Sydney’s North Shore, such as Gordon and Hornsby, are also among the addresses where hundreds of households are on the financial edge of a 30-day default, which is a late mortgage payment.

“Everyone focuses on Western Australia and Queensland but there is a much broader group of households that are closer to the edge and will find it difficult to cope if interest rates go up,” according to Martin North, principal of Digital Finance Analytics, a research company that used 26,000 household surveys to make the predictions.

A late payment demonstrates financial stress and is a long way from an absolute default, or forced sale.

His analysis identifies the amount of headroom households have by stress testing their income against the size of mortgage, whether they have paid ahead and other financial commitments, such as rising fuel, electricity and child minding.

More than 16,000 mainland households are among the nation’s top 20 twenty most vulnerable postcodes and thousands more are at risk of falling behind in payments of interest or principal on their home loan, it finds.

Probability of the top 20 households’ defaulting on mortgage repayments over the next 12 months range from about 3 per cent to 5 per cent, according to the analysis.  A probability rating of more than 2 per cent is “significant”, Mr North said.

Standard & Poor’s Australia, the ratings agency, said most borrowers will stay on top of their mortgage repayments while unemployment levels are relatively stable and interest rates low. Its analysis is based on historical data.

Fixed and variable rates for investors and owner occupiers are rapidly increasing from record lows as the cost of capital funding on international markets has soared in the past two months.

More than 200 mortgage products have increased in the past two months by up to 65 basis points as borrowers recalibrate their loan books in response to a 30 per cent increase in the US 10-year treasury benchmark.

These rises are out-of-cycle to the Reserve Bank of Australia’s (RBA) cash rate movements.

Bankers, such as David Carter, chief executive of Suncorp banking and wealth, are warning rising funding costs is a “trend that is unlikely to change”.

“Generally we expect rates to rise, driven mainly by an expected rise in mortgage rates, as employment and wages growth remain within their current bounds,” said Mr North.

AMP, the nation’s largest financial conglomerate, is the latest to increase rates.

Last Friday (6 Jan) it increased variable interest rates for residential investment loans by 15 basis points for new customers. The same new rate for existing residential investment loans applies from today. (9 Jan)

Most exposed are the young affluent that have taken out large mortgages to pay top prices in an over-heated housing market for houses and apartments, often about inner suburbs where excessive supply is impacting prices.

“Although affluent, many at risk households are grossly over-committed, with little free cash,” Mr North said about young, professional poor-rich in posh inner suburban suburbs of Melbourne and Sydney who are highly leveraged, making minimum repayments and have static income.

“They would be disproportionately impacted by even a small rise,” he said.

Latest RBA analysis shows a sharp rise in debt of about 6.5 per cent over the past year, much higher than income growth.

Latest all-cities average dwelling price from research company CoreLogic, estimates a national increase of nearly 11 per cent in the past 12 months, overwhelmingly concentrated in Sydney, which posted growth of more than 15 per cent, and Melbourne, about 14 per cent.

Western Australia, where house and apartment prices fell by 6 per cent during the past 12 months, dominate the top 20 list of stressed suburbs with nine postcodes, followed by Queensland with six.

Perth real estate agents are forced to provide live entertainment and free coffee to attract bidders to suburban auctions where prices plunged as the mining boom ended.

The DFA analysis shows around 20 per cent of nation’s households would have difficult with a rise of less than 0.5 per cent, another 4 per cent would be troubled by a rise of between 0.5 per cent and 1 per cent and only 35 per cent could cope with a 7 per cent rise.

“The property market will generally still be gaining ground this year, though some regions will be under significant pressure,” Mr North said. “Banks will be seeing losses rising a little, but defaults will remain contained.”

You can listen to my ABC Radio interview for Radio National’s The World Today programme on the same subject.

Channel Nine News Does House Prices and Mortgage Defaults

A segment today from Channel Nine featured the latest data on Sydney residential property, and featured data from the Digital Finance Analytics mortgage default heat mapping, as well as the latest from CoreLogic on Home Prices.

 

Mortgage Default Heat Map Predictions

In our last post for 2016 we have geo-mapped the probability of mortgage default by post code across the main urban centres through 2017. You can read about our approach to the analysis here.

We start with Sydney, which is looking pretty comfortable.

Melbourne is also looking reasonable, though with a few hot spots.

Brisbane default levels are also benign (though the mining areas are more at risk).

Adelaide shows a few hot spots.

But greater Perth is where we think much of the action will be – plus the mining areas beyond the urban area.

As we discussed, our prediction for 2017 is that the property market generally will still be gaining ground, though some regions will be under significant pressure. Banks will be seeing losses rising a little, but defaults will remain contained.

Thanks to those who followed the DFA blog in 2016. We wish you a peaceful new year. We will be back in 2017 with more intelligent insights.

The Full 100 Mortgage Stress Listing

To complete our series on mortgage stress, based on our household surveys, here is the complete list of the top 100 most stressed suburbs, and their relative position on the default list, as at December 2016.

Victoria has the highest number of suburbs in the listing.

As we discussed yesterday, this is based on the absolute number of households in the suburb who are in difficulty.  You can also watch our video blog where we discuss the research.

Running our risk models, we expect the banks to be reporting higher mortgage defaults next year, with a lift in write-offs from around 2 basis points, to 4 basis points. However, this is still at a low, and manageable level given the capital buffers they hold. We do expect provisions though to rise.

New DFA Video Blog – Household Mortgage Stress and Defaults

Using data from our household surveys in this new video blog we discuss the findings from our latest modelling. More than 22% of households are currently in mortgage stress, and 1.9% of households are likely to default. Both are likely to rise next year.

 

Top 20 Postcodes For Mortgage Stress Across Australia

Now we get to the pointy end of our mortgage stress and default analysis. Today we list the top 20 post codes across Australia where the highest number of households currently in mortgage stress reside. We also reveal our estimate for the number of defaults which we expect to occur in the coming months.

It is worth saying that the percentage of households stressed or at risk of default, in a particular post code, varies considerably, but we have chosen to look at the actual number of households this represents. This is because there are a number of post codes where the percentage is very high, but off a very low number of householders. Statistically speaking such low numbers would make us less certain of the accuracy of the estimates. But by choosing to focus on the absolute number of households involved, the estimates are more firmly grounded. In any case the numbers involved, if larger, makes a material difference to the economy, and the banking system.

So, then, here is the list. The post code with the highest number of households in mortgage stress in December 2016 is Harristown – 4350 – in Queensland. It is about 109 kms from Brisbane. This area covers Toowoomba, Harristown, Glenvale and Rockville etc and a population of close to 60,000. Many of the households here are younger. Incomes are lower than the QLD average. More than 4,500 households there are in difficulty and more than 170 households in the district risk mortgage default.

Within the top 20 nationally, the post code with the highest level of default risk is Lamington, WA, a suburb of South East & Central. It is about 549 kms from Perth.  The region includes Kalgoorlie, Lamington and Williamstown, etc. Many of these households are in the younger aged segments.  Incomes are higher than the WA average. Here more than 2,600 households are in mortgage stress, and more than 200 are likely to default.

The distribution of stressed households in also interesting. Within the top 20, Western Australia has the largest number of households (26.4%), just ahead of Victoria (26.38%), but off a smaller population base. Shows the pressure on households in the west.

Next time we will look in more detail at some the state levels data.

A Segmented View Of Mortgage Stress and Default

As we continue our series on mortgage stress, using the latest data from our surveys, we look at how stress aligns with our core household and property owning segments.

To set the context for this, here are a couple of charts showing the mortgage distribution by income and age bands. The majority of mortgages are held by households with an income of between $50,000 and $150,000.

Mortgage stress and default are slightly higher across the lower income bands, but note that households with substantially higher incomes can also be in severe stress. But of course the absolute number are very small.

The highest proportion of mortgages are held by those aged 30-39, more than 30%.

Default probability is higher among younger and older households. Whilst the number of these households with a mortgage is relatively low, more are in severe mortgage stress because their incomes are much lower. More generally, some mortgage stress is evident across all age bands. In volume terms, the highest stress volumes are found in those 30-39 years.

Next we turn to our property segmentation.  Those holding property account for the largest segment of the market. You can read about our segmentation approach here.

Probability of default is highest among first time buyers, who also have the highest proportion of severe mortgage stress. The segment with the lower risk and levels of stress are those seeking to trade up.

On interesting finding, bearing in mind we highlighted the rise of first time buyers seeking help from “The Bank of Mum and Dad“, is that those who do get help are more likely to default. So, assistance from parents may be a two-edged sword.

Finally, we turn to our master segmentation. The number of households with a mortgage varies across these segments. The value distribution footprint is quite different, with the exclusive professional and young affluent segments holding the larger average mortgage.

Mortgage stress is highest among the disadvantaged fringe, though their mortgages are relatively lower and default rates are relatively low. Wealthy seniors registered high levels of severe mortgage stress, thanks to pressure on incomes (the impact of low returns from bank deposits and rentals are important here).

However, the highest risk of defaults sits with the younger segments. Young affluent households, with large mortgages are most exposed because their incomes are flat whilst they are highly leveraged, so as interest rates rise, they are exposed. Many have bought new high-rise apartments in the inner city areas.

Young growing families may have, on average smaller mortgages, but their finances are tight, with little room to maneuver, and any rise in interest rates will be a problem for them. Costs are living are moving higher for this group, especially child care costs.

So, we think effective segmentation is critical to understand the various portfolio risks which reside in the bank’s mortgage book. We need to move beyond LVR and LTI.

Next time we will look at some of the post code level data.