RBA reveals anxiety over housing market risks

Australian Financial Review Apr 13 2017 12:03 PM

Jonathan Shapiro

The Reserve Bank has become more concerned about the surge in household debt and a rise in interest-only loans that is making the financial system vulnerable to a correction in property prices or rising interest rates.

In its semi-annual health check of the financial system, The Reserve Bank issued its strongest warning yet that rampant debt fuelled property speculation, spurred on by tax policies and surging house prices would amplify financial shocks and inflict pain on the entire economy.

"While it is not possible to know what level of overall household indebtedness is sustainable, a highly indebted household sector is likely to be more sensitive to declines in income and wealth and may respond by reducing consumption sharply."

The Reserve Bank said in its 52-page Financial Stability Review published on Thursday.

The report comes as the regulators have responded to surging house prices by doubling down on lending limits and loan underwriting oversight to prevent a further build up of risks posed by an overheated property market.

The bank said a surge in house prices had led to an increase in "the willingness to pay more for a given property and leading to an overall increase in household indebtedness".

In past reports, the Reserve Bank has sought comfort from the fact that, on aggregate households are 17 per cent ahead of their mortgage repayments.

But it has now recognised that these aggregate figures "mask a significant variation across borrowers".

The available data suggests that one third of borrowers - typically borrowers that have recently take out a loan or are on low incomes – has "either no accrued buffer or a buffer of less than one month's repayments".

Investment loans which had concentrated in the hands of already highly indebted households "could induce a more pronounced cycle in housing prices than would otherwise occur, amplifying the situation.

The Reserve Bank's Financial Stability Review document included two 'break-out' chapters to address rising threats to financial stability titled – Interest-Only Mortgage Lending and Characteristics of Highly Indebted Households.

Interest-only loans, where the borrower elects to only pay interest for an initial period of five to ten years have started to rise despite a regulatory crack down in late 2014. They account for 23 per cent of owner occupied loans and 64 per cent of investor lending.

The bank said interest-only loans were expensive as they left the borrower with a typical 30-year $400,000 loan with a balance that was 10 per cent higher after five years while overall interest costs for the life the loan were 9 per cent higher.

Repayments would typically increase by 60 per cent at the end of the period, and while the borrower could refinance "this may be difficult if conditions change".

The RBA also pointed to disturbing findings of reports that some borrowers were applying for principal and interest loans and switching soon after to interest-only loans.

The prevalence of offset and redraw loans gave the RBA some comfort but it said borrowers, who could draw on the loan to fund renovations or other spending needed "to be disciplined in their behaviour".

The Reserve Bank's examination into household indebtedness was limited by the fact that the most recent data was only collected in 2014.

It suggested that highly-indebted borrowers were encouraged by negative gearing to retain debt rather than repay debt.

While there was a prevalence of highly indebted borrowers on low income, this group only accounted for 12 per cent of the overall debt owed by highly-indebted borrowers.

The most indebted borrowers had increased their exposure away from business loans towards investment property lending.