Housing affordability is worsening, warns ratings agency

From Mortgage Professional Australia.

Moody’s report shows regulatory crackdowns and low-interest rates will not protect affordability, putting pressure on Government to take action in the Budget

Housing affordability is deteriorating in Australia despite the impact of regulatory crackdowns and low interest rates, a report by international ratings agency Moody investors Service has found.

Affordability worsened in the year to March 2017, with interest repayments requiring for 27.9% of household income on average, compared with 27.6% in March 2016. Affordability declined steeply in Sydney, Melbourne and Adelaide, according to the report, although it improved in Brisbane and Perth, which is currently the most affordable city in Australia, with the proportion of income going to repayments at 19.9%.

Moody’s expect that housing affordability will continue to deteriorate, blaming “rising housing prices, which outstripped the positive effects of lower interest rates and moderate income growth”. Whilst APRA’s restrictions on interest-only mortgage lending could dampen demand for apartments they could also reduce affordability, Moody’s claims: “the new regulatory measures have prompted some lenders to raise interest rates on interest-only and housing investment loans, which will make such loans less affordable.”

Proportion of joint-income required to meet interest repayments, March 2016:

  • Sydney 37.5%
  • Melbourne 30.3%
  • Brisbane 23.9%
  • Adelaide 23%
  • Perth 19.9%
  • Australia: 27.9%

Coming just weeks ahead of the 2017-18 Federal Budget, Moody’s report indicates the Government cannot rely on regulators and the RBA if it wants to improve affordability. In March Treasurer Scott Morrison said repayment affordability would play a major part in the Budget and was a bigger issue then the difficulty of first home buyers, whilst ruling out any changes to negative gearing.

In a series of sensitivity tests, Moody’s demonstrated the risks faced by Australian homeowners. Looking at the effect of house prices continuing to rise, income decreasing and interest rates increasing, Moody’s found Sydney homeowners were particularly vulnerable. A 10% rise in property values – far from unknown in the harbour city – meant an extra 3.8% of income needed to meet mortgage repayments.

Moody’s report did find that affordability was unchanged for apartments. Apartment owners spent an average of 24.5% of their income on repayments, compared to 29.3% for house owners. This is a national average: affordability of apartments did decline in Sydney and Melbourne.

It’s Not Just Low Income Households In Mortgage Stress

So the banking analysts are lining up to talk about the risks in the housing market, and the potential impact on bank earnings. But the latest line being peddled is that the major risks are located among low income – small mortgage – urban fringe – households.

But this is just not true. Our household surveys, probably the most accurate and current view of households financial footprints, tell a different story. We have already explored this from a segmented perspective, and highlighted that affluent households are also exposed – they have the big incomes and life-styles, but also the mortgages to match.

Here is a different view, mapping income bands to loan to income (LTI) bands. LTI is relevant because traditionally a ratio of much above 3 times begins to look more risky, especially in a low income growth environment.

First we look at the relative distribution by count of loans. This visualisation shows that around 55% of loans are sitting in the 3 times or below LTI range, and 68% of the loans are sitting in the household income bands  below 100k. But this is deceptive.

An alternative and more concerning view is based on the value of loans outstanding. This next visualisation shows that by value the loans spread up the income bands, but also spread across the loan to income bands. In fact only 28% of loans by value sit at LTI’s below 3 times and 34% sit with household incomes of $100k or below.

So, once you take the relative size of loans into account, mortgage stress breaks the boundaries of “low income, small mortgage” households. The problem is much more deep seated, and more affluent households are some of the most leveraged, to the point where small rate rises will hurt, especially where they have both owner occupied and investment mortgages.  They are also less likely to know how to respond, whereas the battlers are use to sailing close to the wind in terms of managing a household budget.

$100 tipping point for 57% of mortgage holders

From Australian Broker.

A staggering 57% of mortgage holders could not handle a $100 increase in their loan repayments, according to new research by Finder.com.au.

This additional $100 is equivalent to an interest rate rise of just 0.45% based on the national average mortgage of $360,600. This means the average standard variable rate of 4.83% would only have to rise to 5.28% to put more than half of mortgage holders in stress.

With increasing interest rates, some borrowers have little breathing room, said Bessie Hassan, money expert at Finder.com.au.

“The typical mortgage holder will begin to struggle once interest rates reach around 5.28% – that’s a pretty small window before borrowing costs start to hurt,” she said.

“The reality is borrowers have over-extended themselves if it only takes a $100 leap in repayments for more than half of homeowners to reach their tipping point.”

Hassan expressed concern about mortgage holders and their exposure to mortgage stress, especially with rising rates forcing borrowers to use a greater percentage of income on their loans.

Looking at higher rate rises, the research found 18% of borrowers could handle a monthly repayment increase of $250 while just 14% could manage $1,000 or more.

There is a $209 monthly difference between the cheapest fixed interest rate (3.59%) and the most expensive (4.59%), Hassan said, meaning borrowers could be “throwing away thousands of dollars” per year.

With the research also showing that 39% of all mortgages are interest-only, this highlights why the Reserve Bank of Australia (RBA) and the Australian Prudential Regulation Authority (APRA) have shown some concern, she added.

Comparing genders, 63% of women and 50% of men would struggle to repay their mortgages with an increase of less than $100 per month.

Across the states, South Australian borrowers were the worst placed with 70% saying they could not handle an increase of less than $100 per month. This figure was lower in New South Wales, Tasmania and Western Australia at 59% and further dropped to 51% in Victoria.

Latest On Victorian Mortgage Stress

Today’s coverage in the Herald Sun looking at sensitivity analysis of mortgage stress in Victorian households received significant attention. Several tv news programmes tonight will continue the coverage.

Here is a summary of the current levels of mortgage stress – around 300,000 households are feeling the pain of higher mortgage rates, flat incomes and rising costs of living. Not a good formula.

As well as those in the mortgage belt, some in the more affluent areas are also in difficulty. We modelled the impact of a 2% rate rise – the number of households in pain would double.

Note also that investment property holders are also under the gun, thanks to the recent rounds of mortgage repricing, despite flat rental yields.

This could get rather nasty. The best outcome would be a period of stagnant prices, the more likely is a correction as the chickens come home to roost!

More warnings about the Australian housing market

From wsws.org.

Australian house prices have continued their unprecedented ascent, with median home values in Sydney this week hitting a record $1.15 million and in Melbourne, $826,000, after rising by 13.1 percent and 7.6 percent respectively in the first three months of the year.

The frenzied growth of the east coast market has prompted a series of warnings pointing to the contradiction between inflated house prices and the stagnant or declining incomes of working people, amid a slump across manufacturing and other industries.

Last week, Moody’s cautioned that Australia’s housing market was among four in the world most susceptible to a crash in the event of an economic shock or a renewed downturn. The international ratings agency drew attention to the mountain of debt upon which the property bubble has been built, stating: “Australian households stand out for lower financial buffers and higher leverage.”

Moody’s drew a parallel between debt-to-liquid asset ratios in Australia, and in Ireland before the collapse of the property market in 2007. It commented: “[I]n the event of a negative income shock, the scope for Australian households to draw down parts of their financial assets to maintain debt service and overall spending is more limited than elsewhere.”

Deloitte Access Economics likewise pointed to the buildup of debt this week, noting that household debt to income ratios are the second highest in the world after Sweden. National household debt currently stands at 185 percent of annual disposable income, up from around 70 percent in the early 1990s.

Deloitte has estimated that house prices are around 30 percent overvalued compared to national income, the highest margin in over three decades. The firm’s director, Chris Richardson warned that in “global terms our housing prices are asking for trouble.”

In comments to the National Press Club last week, Richardson warned of the vast implications of any slowdown of the Chinese economy for the Australian housing market and financial system. He predicted that a sharp crisis in China could result in the collapse of house prices by around 9 percent, as part of a broader downturn that could destroy almost $1 trillion of national wealth.

Martin North, of Digital Finance Analytics, drew parallels with the US subprime mortgage crisis that played a key role in precipitating the global financial crisis of 2007–08. He listed declining incomes, rapidly rising household debt and a growth in mortgage stress as features in common.

North told Fairfax Media: “This falling real income scenario is the thing that people haven’t got their heads around.” National wage growth across the private sector was just 1.8 percent last year, the lowest level since records began in 1969. Modelling by North has indicated that 669,000 families, or 22 percent of borrowing households, are already in mortgage stress.

Other reports have pointed to the mounting social crisis caused by the ongoing rise in house prices, prompting warnings of a rise in mortgage arrears and defaults.

In its Financial Stability Review released last week, the Reserve Bank reported that around one third of mortgaged households have not built up any substantial repayment buffer, or are a month or less ahead of mortgage repayments. In other words, they are vulnerable to economic fluctuations and any change in their circumstances.

An ALI Group survey last month showed that 41 percent of homeowners feared that they would be unable to keep up with mortgage repayments if they lost their job.

This finding tallied with figures late last year from financial management software company Moneysoft, which found that more than 25 percent of non-investor home loans were “unhealthy.” Loans were deemed to be in bad health if they had grown by at least 5 percent over the course of the loan. Another 25 percent were termed “neutral,” meaning that they had neither grown nor substantially fallen.

The precarious situation of many has contributed to a growth in delinquent housing loans. They rose from 1.15 percent of all housing loans last December, to 1.29 percent in January, according to Standard and Poor’s. In some states the figure is far higher, with Western Australia, which has been hit by the collapse of the mining boom, registering 2.33 percent.

These conditions have led to intensified calls for the Reserve Bank to raise its official interest rate from a historic low of 1.5 percent, and take other measures to rein in speculative loans, including interest-only loans that do not require the borrower to pay off any of the principal for fixed periods of up to seven years.

Minutes from the central bank’s April meeting stated that it “would consider further measures if needed,” but did not spell them out. Any rise in interest rates, however, could lead to a rapid fall in borrowing, along with a rise in mortgage defaults, potentially provoking a dramatic contraction of the entire market.

The soaring cost of housing, which has made it unaffordable for many young people, has intensified the crisis of the Liberal-National government of Malcolm Turnbull. Like its Labor Party predecessor, the government has maintained capital gains tax concessions, and other policies, such as negative tax gearing, which have provided a boon for property developers.

Amid reported divisions within the government, various proposals have been floated, including allowing first homebuyers to access their superannuation funds to purchase a house and making limited reductions in the 50 percent capital gains tax concessions.

The Labor Party has demagogically denounced negative gearing tax incentives for investors. Their posturing was punctured by reports this week that federal Labor politicians own some 72 investment properties in total. Their Liberal-National and Greens colleagues likewise have substantial material interests in the ongoing housing boom.

None of the measures being discussed by the government, or any section of the political establishment, will resolve the housing affordability crisis and the massive growth of property market speculation that has fuelled it.

Loans to investors made up around 39 percent of all housing loans in January, with only 7 percent of loans for first homebuyers. The proportion of investors is higher in Sydney and Melbourne, the centres of the property boom.

According to the Australian Bureau of Statistics, investor loans grew by 27.5 percent on a seasonally adjusted basis, between January 2016 and 2017. The growth was well above the 10 percent annual limit placed on the banks by regulatory authorities.

The rise has coincided with an ongoing decline in productive investment. Corporate investment in new buildings, equipment and machinery fell in each quarter last year, with a decline of 2.1 percent in the December quarter alone.

As has happened around the world, the deepening crisis of global capitalism and the escalating slump in the real economy has seen the corporate elite turn to ever-more speculative financial operations. These do not produce real social wealth but inflate the value of existing assets, in this case, leading to a housing crisis for millions of working people.

Negative gearing exposing Australia’s poor: KPMG

From Financial Standard.

KPMG warns any increase in Australia’s historically low interest rates would cause serious economic problems and affect households across the entire financial spectrum, from rich to poor.

The industry consultant said one of its biggest concerns is that Australian households have progressively increased debt levels at rates faster than their disposable incomes have grown.

Most notably, KPMG economists highlight some of Australia’s poorest citizens are taking on negatively geared property investments when there’s a clear inability to manage the financial risks.

Analysing the incomes and spending of Australian households over the past 20 years, KPMG said household income has primarily grown because of investment income and government transfers, not rising wages and salaries.

The firm added that more than one-third of the income of the poorest 20% of Australian households is received through government transfers.

Its report finds the bottom 20% of households recorded the highest rate of growth in investment income, at 8.5% per annum, compared to an average of 2.3% over the past decade for other households.

KPMG Australia chief economist Brendan Rynne said: “While it is perhaps understandable that the poorest members of our society want to diversify and increase their incomes, this group is the least able to take on the financial risk associated with geared investment activity.”

The second 20% of lowest-income households, or those slightly better-off, are getting relatively more than the lowest bracket in terms of (government) dollar transfers received per dollar tax paid. KPMG said this suggests policies to deliver welfare to the poorest members of society are less effective than to slightly better-off recipients.

“The proportion of households that end up paying no net tax – but via an administratively costly money-go-round of paying income tax and then getting it all or more sum back via income support payments, has now reached 60%,” Rynne said.

He says the answer is not further ratcheting up marginal tax rates for higher tax earners.

“Our analysis shows that the top 20% of households already pays 50% more income tax than the bottom 80% combined,” he said.

Tracing The Rise Of Mortgage Stress

We updated our mortgage stress models recently, which showed that around 669,000 households are in stress, which represents 21.8% of borrowing households.  Those results are a point in time view of households finances. The RBA also said that one third of households have no mortgage buffer.

Today we take a longer term view of the rise of mortgage stress, which is driven by a combination of larger mortgages, flat incomes, higher living costs and rising debt.

The first chart tracks household debt to disposable income from the RBA, as well as mortgage rates, the cash rate and both CPI and wage growth.

Stress levels rose consistently through the  early 2000’s as debt and mortgage rates rose, to reach a peak of 19%, when the cash rate was 7.25%, the average variable mortgage rate was 9.35% and the household debt to disposable income sat at around 170. Those with a long memory may remember that we were warning about this trend in the 2000’s.

But then the GFC hit, rates were cut, and mortgages rates fell sharply to 5.8%. However the debt to disposable income ratio only fell a little to 168.

Lower rates stoked demand for property, so prices started to rise, and mortgage rates moved higher, then lower as the RBA used housing to try to fill the gap left by the mining sector moving into the production phases.  Household debt to disposable income has since moved higher to a new high of 189 and is still rising.

During more recent times, mortgage stress and household debt has been moving up – and the latest stress data shows an acceleration as income growth all but stalls, and costs of living keep going, mortgage rates are rising.

To look at this in more detail, here is the same data, but with CPI and wage growth now mapped to stress and the cash rate. The fall in wage growth is significant, and this has now become one of the main drivers of stress.

My point is, nothing has suddenly changed. The inexorable rise in household debt, especially in a low wage growth scenario was obviously going to lead to issues (see our posts from 3 years back!) and so the RBA’s apparent volte-face is a welcome paradigm shift, but late to the party. Perhaps the New Governor had a different perspective from the previous incumbant!

Of course the question now is, can this be managed without a property correction?  Probably not.  Read our definitive guide to mortgage stress here.

One final point. In the recent Financial Stability report, the RBA used HILDA data to argue that household financial stress was not too bad.  But the data is not that recent, latest from 2014 and 2015, and since then our surveys highlight that some more affluent households are also being squeezed, especially as mortgage rates rise, and their incomes stall; they are highly leveraged.

The HILDA Survey also includes questions on financial stress experienced by households over the previous year.  There was a broad-based decline in the share of households experiencing episodes of financial stress between 2001 and 2015 (the time span available in the HILDA Survey). Nonetheless, households that were highly indebted in a particular year had a greater
propensity to experience financial stress. For instance, households that were highly indebted in 2002 were more likely to experience at least one incidence of financial stress in all other years compared with households that were less indebted in 2002 (Graph C5, right panel). The result also holds true for other cohorts. This suggests that a greater share of highly indebted households face financial difficulties and are more likely to be vulnerable to events that affect their ability to repay their debt, such as income declines or increases in interest rates.

Overall, these data highlight that highly indebted households can be more vulnerable to negative economic shocks and pose risks to financial stability. In particular, highly indebted households are less likely to be ahead of schedule on their mortgage repayments and they are more likely to experience financial stress, hence could be more vulnerable to adverse macroeconomic shocks. The consequent effects of this stress on the broader economy may be exacerbated by the disproportionately large share of investor housing debt owed by highly indebted households. Hightened investor demand can contribute to the amplification of the cycles in borrowing and housing prices, particularly when this investment is highly leveraged. Nonetheless, HILDA data also show that much of the debt held by highly indebted households is owed by households with high income and wealth, who are typically better placed to service larger amounts of debt.