More On Household Debt, From The ABC

ABC’s RN Breakfast‘s Business Reporter Michael Janda discussed household debt as part of his segment on Radio National Breakfast this morning, and was kind enough to mention our recent research on owner occupied and investment housing debt sensitivity.

There was a subsequent flurry on Twitter discussing the DFA research approach.

To be clear, our household modelling is based on a rolling 26,000 statistically robust omnibus survey, to which each month we add 2,000 new households and drop off the oldest set. We have data from more than 10 years of research and it feeds our programme of activity and is reflected in the DFA blog.

From a mortgage stress perspective, we run our modelling, based on our household profiles and segments, which looks at net cash flow (before tax) and we also sensitive the modelling based on potential future rate movements. We take account of their total financial position, including other debt demands, and costs of living.

You can read more about our modelling here.  If you want to read our mortgage stress work, this overview is a great place to start.

P.S. Our research is separate and distinct from other research in the housing affordability arena, including the international Demographia survey. Whilst some of the findings may align, the research is based on different underlying research sources.


So Just How Sensitive Are Property Investors To Rising Interest Rates Now?

Having looked at changes in investment loan supply, and the motivations of the rising number portfolio property investors, today we use updated data from our rolling household surveys to look at how property investors are positioned should mortgage rates rise. In fact, for many, rates have already been raised, thanks to lender repricing independent of any RBA cash rate move, some as much as 65 basis points. We think there is more to come, as loan supply gets tighter, international financial markets tighten and competitive dynamics allows for hikes to cover capital costs and to bolster margins.

To assess the sensitivity we model households ability to service mortgage debt, taking into account their other outgoings, and rental income.  We are not here looking at default risk, but net cash flow. How high would rates rise before they were under pressure? Where they also have owner occupied loans, or other debts, we take this into account in our assessment.

The first chart is a summary of all borrowing investor households. The horizontal scale is the amount by rates may rise, and for each scenario we make an assessment of the proportion of households impacted, on a cumulative basis. So as rates rise, more households would feel pain.

The summary shows that nationally around a quarter of households would struggle with a rate hike of up to 0.5%, and as rate rose higher, this rises to 50% with a 3% rate rise, though 40% could cope with even a rise of 7%.

So a varied picture. But it gets really interesting if you segment the analysis. Those who follow DFA will know we are a great believer in segmentation to gain insight!

A state by state analysis shows that households in NSW are most exposed to a small rate rise, with 36% estimated to be under pressure from a 0.5% rise (explained by large mortgages and static rental yields), compared with 2% in TAS.

Origination channel makes a difference, with those who used a mortgage broker or advisor (third party) more exposed compared with those who when direct to a lender. The pattern is consistent across the rate rise bands.  This could be explained by brokers knowing where to go to get the bigger loans, or the type of households going to brokers.

Households with interest only loans are 6% more exposed to a small rise, and this gap remains across our scenarios. No surprise, as interest only loans are more sensitive to rate movements. We have not here considered the tighter lending criteria now in play for interest only lending.

Our master segmentation reveals that it is Young Affluent and Young Growing Families who are most exposed, followed by Exclusive Professionals. Some of the more affluent are portfolio investors, so are more leveraged, despite larger incomes.

Finally, we can present the age band data, which shows that those aged 40-49 have the greatest exposure as rates rise, though young households are most sensitive to a small rise.  Note this does not reveal the relative number of investor across the age groups, just their relative sensitivity.

This all suggests that lenders need to get granular to understand the risks in the portfolio. Households need to have a strategy to prepare for rate rises and should not be fixated on the capital appreciation, at the expense of cash flow management, especially in a rising rate environment.

Housing affordability and the changing debt burden

Excellent opinion piece (and charts) in the Guardian by Philip Soos, which nicely underscores the debt burden issue we have been highlighting.

Australia’s historically high and rising housing prices are widely debated and have prompted a number of government inquiries into housing affordability.

The question stands open: is housing affordable in Australia?

Affordability is often confused with related concepts such as ease of entry, serviceability and valuation. Ease of entry refers to the difficulty of purchase, whereas serviceability measures the burden of mortgage repayments relative to household income.

Valuation considers whether prices are efficient relative to economic fundamentals. Opinions are divided on this: housing prices could be 30% undervalued, a bubble which is 40% overvalued, or somewhere in between.

It is often claimed housing is affordable because nominal mortgage interest rates are low, having significantly declined since the peak of 17% in 1990. The standard mortgage payment formula shows nationwide debt repayments relative to household incomes are lower today than in 1990 and the smaller peak in 2008.

Australia mortgage payments % income

This metric is problematic because it is static, capturing the payments-to-income ratio at each particular point in time. The ratio at the peak in 1990, for instance, is very high if, and only if, prices, interest rates and incomes are constant over the life of the mortgage. This doesn’t reflect reality and a more dynamic approach is required.

First, the deposit-to-income ratio is the highest on record. Lenders may accept smaller deposits today but this is not a genuine choice for first home buyers. Starting out with larger loan repayments and lower equity is unlikely to be compensated for in a low interest rate and anaemic wage growth environment, especially with the added cost of lenders mortgage insurance.

20% deposit as % of household income

Second, due to larger mortgages, repayments are higher than suggested by interest rates alone. Unfortunately, principal repayments are not officially recorded in our national accounts. The Bank of International Settlements has developed internationally standardised debt service ratios (DSR) to derive estimates of aggregate principal and interest repayments to income.

Household debt and prices escalated, interest rates declined and principal payments rose over the years. The gap has widened between interest payments to income and the DSR from around 1% between the late 1970s and early 1990s to a record 6% today.

By disregarding rising principal payments, vested interests downplay the immense debt burden assumed with a typical mortgage.

debt payment to household income rates

Worryingly, the bank states, “the DSR is a reliable early warning indicator for systemic banking crises. Furthermore, a high DSR has a strong negative impact on consumption and investment.” The DSR is currently 15% nationwide, far higher than the US, UK and Spain at the peaks of their housing bubbles. Estimates of the DSR for New South Wales and Victoria are 18%, which demonstrates extreme indebtedness.

Third, past research from the RBA recently surfaced in the media, examining the effects of wage inflation on mortgage payments. While high interest rates result in onerous payments relative to income, this only occurs in the early phase as high wage growth inflates away the burden. In contrast, borrowers facing high housing prices with low interest rates and poor wage growth face a greater burden across the life of the mortgage due to greater payments-to-income.

Everyone apart from the very wealthy has to purchase with a mortgage. Therefore, only by anchoring serviceability of payments-to-income can a genuine estimate of affordability be made. Generally, 30% of income is the accepted maximum.

High wage growth relative to interest rates and prices during the 1960s and 1970s made housing quite affordable. Higher prices and interest rates in the 1980s increased the burden. When interest rates peaked in 1990, payments were arduous but quickly declined.

While interest rates and wage growth for the next 25 years cannot be known, they are assumed to hold still at the present rates: 5.7% for the average imputed mortgage interest rate and 1.4% for wages. While the present interest rate may seem high, lower rates will inevitably prompt further housing price growth.

Buyers from, say, 2010 face onerous payments over the life of their mortgage compared to those who purchased in 1980 and 1990 when interest rates were much higher. The average ratio across the lifetime of the mortgage for all purchases dates are 1960 (10%), 1970 (10%), 1980 (18%), 1990 (27%), 2000 (23%) and 2010 (37%).

Although not shown, affordability is even worse in 2016 due to rising prices, with an estimated average payment ratio of 42%. The payment burden for 2010 and 2016 is still extreme and higher than 1990, even when factoring in lower estimated interest rates (4%) and higher wage growth (2%).

Mortgage payments graph
Mortgage payment graph

The measures presented above are absent from mainstream analysis today precisely because they demonstrate severe unaffordability, confirmed by the highest deposit-to-income ratios, the highest debt repayments relative to income over the lifetime of the mortgage and very high DSRs. Over 50% of first home buyers today are reliant on parental assistance.

There are three ways to assist affordability: declining interest rates, rising wage growth and falling housing prices. Aspiring first home buyers are severely disadvantaged; nominal wage growth is currently at the lowest level since the second world war and there is little room for interest rates to go lower. The only path to improved affordability is by reducing housing prices.

This is obviously opposed by political parties, the finance, insurance and real estate sector and economists employed by vested interests. Instead, we are bombarded with a disgraceful litany of pronouncements, fabricated to defend record high housing prices and unaffordability.

Young adults are condemned as lazy and inept, allegedly misspending their income on alcohol or stuffing themselves with smashed avocado toast in hipster cafes. To protect unjustified privilege – unearned rises in housing prices – vested interests have twisted a very real affordability crisis into moral failing by the young. They are told to get onto the housing ladder by purchasing an investment property or to “get a good job”.

The appalling government report recently published on home ownership (at which I testified) was a miserable 45 pages short and made no recommendations. The government made no pretense of objectivity; dissenting reports by the ALP and Greens were more informative.

The evidence shows housing prices and unaffordability are at record highs. This appalling state of affairs is maintained by an undemocratic politburo of vested interests accustomed to extracting a staggering proportion of unearned income and wealth. Manufacturing claims of youthful indolence is merely another day at the office.

Will anything be done to lower housing prices? On the contrary, the politburo endlessly champions higher prices by seeking further interest rate cuts, increasing our already third-world rates of population growth via immigration and could implement another inflationary first home owners boost on the pretext of assisting first home buyers – which enriches existing landholders and bankers.

The state of policymaking and economic management in Australia is extremely poor and entirely intentional. If the young are to learn an important lesson, it is this: no matter how hard things are, vested interests are committed to making their lives ever more difficult.

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


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.


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

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.


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

“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.”


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.” 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

US Mortgage Rates Add Stress for Millennial Homebuyers

Fitch Ratings says the recent rise in US interest rates adds another obstacle for millennials seeking to enter the housing market.

Based on our calculations, the rate increase means the average US millennial borrower now has lost 9% in mortgage capacity since the beginning of October 2016. This leaves more millennials out of what has historically been one of the most important wealth-creation mechanisms, and could contribute to long-term shifts in savings and consumption.

Mortgage rates nearly hit a two-year high during the week of Jan. 5, 2017 according to Freddie Mac. The interest rate on a 30-year mortgage at the beginning of October 2016 was 3.42%. Last week, the rate climbed to 4.20%. The maximum loan a homebuyer could afford in September 2016 was $120,000 (the current median mortgage for borrowers under 35 according to the Federal Survey of Consumer Finances), all else being equal, the size of that loan would have dropped to approximately $109,000 by last week.

Historically low rates have been one of the few factors that have helped young adults to buy homes. If rates continue to rise, particularly if the rise occurs rapidly over a short time period, this could add yet another obstacle to homeownership. Many first-time homebuyers have seen mortgage capacity eroded by tight loan underwriting standards, rising student loan payments, high rents and stagnant wages.

The growth in the cost of higher education outpaced consumer price inflation for several decades. This led to an increase in both the number of student loan borrowers and the average amount owed. The median student loan monthly payment in 2016 was $203, according to the Federal Reserve Bank of Cleveland.

Tight underwriting played a significant role. Banks remain vigilant over regulatory risk, repurchase risk and the increased cost of servicing of delinquent loans. This means FICO scores for conventional loans to first-time homebuyers remain notably above the 720-730 range level typical prior to the crisis, although the scores have begun trending back toward historical averages.

The stresses are reflected in the US homeownership rate and increases in the portion of millennials who live at home. The homeownership rate for under 35-year-olds experienced a large drop, declining to 35% in 2016, from 41% in 2000, according to the US Census Bureau. During this time, rental costs increased faster than the incomes millennials earn.

For younger Americans forced to defer or abandon plans to buy a first home, the long-term financial effect of missing out on home-equity creation could be significant. Long-lasting shifts in savings and consumption patterns, while difficult to isolate now, will likely emerge more prominently in the coming years. This could mean other long-run affects including downward pressure on durable goods consumption, urban population growth and a decline in affluence, translating into lower birth rates and less secure retirements.

How Households Will Respond To Interest Rate Rises

We have updated our analysis of how sensitive households with an owner occupied mortgage are to an interest rate rise, using data from our household surveys. 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.

To complete this analysis we examine 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. We then run scenarios across the data, until they trip the mortgage stress threshold.

At this level, they will be in difficulty.  The chart shows the relative distribution of borrowing households, by number. So, around 20% would have difficulty with even a rise of less than 0.5%, whilst an additional 4% would be troubled by a rise between 0.5% and 1%, and so on. Around 35% could cope with even a full 7% rise.

If we overlay our household segments, we find that young growing families and young affluent households are most exposed to a small rate rise. However, some in other segments are also at risk.

State analysis highlights that households in NSW are most sensitive, a combination of larger volumes of loans as well a larger loans, relative to incomes resulting is less headroom.

Younger households are relatively more exposed, because their incomes tend to be more limited and are not growing in real terms relative to mortgage repayments.

Analysis by DFA property segment shows that whilst some first time buyers are exposed at low rate movements, those holding a mortgage with no plans to change their properties (holders) are also exposed. In addition, some seeking to refinance are doing so in the hope of reducing payments, because they have limited headroom.

Finally we turn to other insights from our data. First, those households who sourced their mortgage via a mortgage broker are more likely to be in difficulty with a small rate rise, compared with those who went direct to a bank. This, once again, shows third party loans are more risky. This perhaps is connected to the types of people using brokers, as well as the broker’s ability to suggest lenders with more generous underwriting standards and coaching on how to apply successfully.

We also see that rate seekers (we call these soloists) who are driven primarily by best rates, are more sensitive to small rate rises, compared with those who are more inclined to seek advice, and appreciate service more than price (we call these delegators).

Soloists who went via a broker are the most exposed should rates rise even a little, whereas delegators going to a bank, are more able to handle future rises.

Segmentation, effectively applied can results in quite different portfolio outcomes!

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.

Fears rise as mortgage stress strikes bush, city

From The Australian.

In Lamington, a country area of Western Australia covering mining towns such as Kalgoorlie, 2600 households are suffering “mortgage stress”.

The pain is more severe in Harris­town in Queensland, about 130km west of Brisbane, where more than 4500 households are in difficulty.

For the banks, more than 370 in these areas alone are likely to default, or fall more than 30 days ­behind on repayments, according to data from Digital Finance Analytics.

Research covering the top 20 postcodes with the greatest mortgage stress features many country areas but Melbourne’s Essendon and Preston each have around 2500 households in difficulty, as does western Sydney’s Bossley Park.

Despite record low interest rates and unemployment below 6 per cent, Standard & Poor’s yesterday said arrears ticked higher in October and the proportion of “non-conforming” borrowers behind on payments was near record levels.

DFA’s data, based on a rolling survey of 2000 households a month, suggests the trend will worsen. It also suggests first time home buyers who received help from the “bank of mum and dad” were more likely to default.

“The issue will be what happens to interest rates. If interest rates don’t go up, then some of this won’t flow through, but I think all the expectations are that interest rates will rise,” said DFA analyst Martin North, who is factoring in a 50 basis point increase in rates next year.

Banks in recent weeks have hiked mortgage rates for many customers out of sync with any RBA changes, which analysts said could put customers under greater pressure amid meagre income growth.

Mr North said: “My own models predict a higher rate of loss than they (banks) are currently predicting themselves.”

The RBA yesterday signalled borrowers were unlikely to win any imminent reprieve on their debt repayments early next year.

After cutting rates since late 2011, the RBA’s minutes of its monthly board meeting revealed greater concern about the “balance” between low rates supporting economic growth and the “potential risks to household balance sheets”.

“Members recognised that this balance would need to be kept under review,” the RBA said.

Westpac chief economist Bill Evans said the RBA was concerned the benefits to spending from lower rates were not compensating for the instability in asset markets, heightened by record high household debt.

“This observation is signalling that the hurdle to even lower rates which would be aimed at boosting demand is very high,” he said. As house prices soared more than 65 per cent in Sydney in the past four years while floundering in other areas, some hedge funds and analysts have flagged overgeared households and a sagging real economy were increasing the risks of a housing correction.

US-based asset manager AllianceBernstein yesterday warned that potential “disorder” in the housing sector in the second half of next year clouded the outlook for Australia’s investment markets. Former Commonwealth Bank chief David Murray this month said all the signs of a housing “bubble” were prevalent, such as “people’s behaviour … and ­defensiveness about any correction”.

Mr Murray told Sky Business that investors owning multiple properties that were cross-collateralised who could become forced sellers were the “risk to the system”. But the big banks have repeatedly tried to ease fears about the risks, citing relatively low unemployment and most customers being ahead on their loan repayments.

Westpac last month reported actual mortgage losses after insurance eased to $31 million, or just 2 basis points of its loan book. The number of consumer properties in possession rose to 262, from 253 in March.

ANZ and Bank of Queensland, however, recently flagged concerns about stagnant wages, underemployment and the apartment glut in eastern cities.

According to DFA’s survey, around 80 per cent of households were travelling well and only 20 per cent were under stress, struggling to make repayments or having to cut back on spending.

Mr North said low wages growth and rising education and healthcare costs suggested borrowers’ financial situations would not improve. He predicted the banking industry’s loss rates would rise to about 4 basis points of mortgage loans, varying among lenders’ portfolios.

He said banks concentrated in troubled areas, such as WA, would be harder hit.

After the pick-up in bank stock prices since last month, CLSA analysts yesterday reminded investors that all were at risk of favourable loan-loss trends of recent years reversing and that CBA was more exposed than peers to WA.

WA has the largest proportion of stressed households at 26.4 per cent, just ahead of Victoria, but off a smaller population base, according to DFA’s survey.

Mr North said: “I’m theorising there is more risk in the mortgage book than I think the RBA recognises and more risk than some of the risk models used by the banks. It’s not dramatic … I’m not saying the world is caving in. 80 per cent of the book is fine.

“But it’s enough to at least be aware of.”

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.