Aussie households can service their loans even if the cash rate gets to 3.6% – RBA

Key takeaways

Recent RBA modelling shows that overall the majority of variable rate mortgage households are likely to be well placed to manage higher minimum loan repayments should the RBA cash rate rise by another 1% to 3.60%.

Households will meet higher minimum mortgage repayments by drawing down on savings buffers, or paring back on real non-essential consumption.

95% of owner-occupier variable rate borrowers will still face a reduction in free cash flow, with such reductions being large for around 50% of borrowers.

On the upside it is clear that around half of variable rate owner-occupier households have large buffers - 55% would not exhaust buffers for at least two years even with higher minimum repayments if they chose to maintain non-essential spending.

On the downside, 30% would exhaust buffers with higher minimum repayments within six months if they maintained non-essential spending at current levels.

How would you cope if interest rates rose a further 1%?

Well according to the semi-annual RBA Financial Stability Review most Aussie households would manage to cope well.

Of course, that's against what the media is telling us about severe mortgage stress leading to Real Estate Armageddon

You see... only around a third of households have mortgages in Australia.

That’s because half of those who own property don’t have a mortgage against it, and a third of Australia’s population tend to be renters.

The RBA modelling was for variable-rate loans which comprise around 65% of outstanding mortgage debt.

So far the RBA has delivered 2.5% worth of hikes and the FSR modelling explored what would happen if there was an extra full 1% of hikes which to take the RBA cash rate to 3.60%.

The conclusion was that “overall, most borrowers are likely to be well placed to adjust their finances, with only a small share appearing vulnerable to falling into arrears”.

What does this mean for further interest rate hikes?

The analysis suggests households should be able to weather an RBA cash rate of 3.6% without raising any financial stability concerns.

Whether the cash rate needs to get to that level will of course depend on the outlook for inflation and how households respond to higher rates – to what degree do they draw down on accumulated savings buffers and/or reduce real consumption.

Many are suggesting there are signs that rate hikes may be nearing their peak.

This is what the Big Four banks are now forecasting as of the beginning of October 2022

• CBA: +0.25% in Oct, peaking at 2.85% in November. Two 0.25% cuts in August and November 2023.
• Westpac: +0.50% in October, peaking at 3.60% in February 2023. Four 0.25% cuts in 2024.
• NAB: +0.50% in October 2022, peaking at 3.10% in November 2022.
• ANZ: +0.50% in October, peaking at 3.35% in December 2022. Two 0.25% cuts in 2024.

How would borrowers cope?

Tapas Strickland, CFA, Head of Market Economics, Markets Corporate & Institutional Banking at the NAB  explains what could occur
National Australia Bank Limited

• The RBA modelling shows that around 40% of borrowers would face a moderate decrease in spare cash flow of less than 20% from mid-2022 levels and would be able to accommodate this reduction through reduced non-essential consumption and/or saving less of their income.
• Around 50% of borrowers would face a decrease in spare cash flow of 20% or greater. Importantly for the vast majority of these (35%) spare cash flow would still be positive. However, 15% of borrowers would see spare cash flow turn negative (i.e. repayments and essential living expenses exceeding income).
• Around 5% of borrowers would see an increase in spare cash flow given low debt levels and ongoing income growth (i.e. income growth would exceed the increase in minimum debt repayments).
• The reduction in spare cash flow seen by around 95% of borrowers above could be partly met by reducing accumulated savings buffers, so the impact on actual real consumption is uncertain.
  • Under the scenario where households do not reduce non-essential real consumption, around 30% of borrowers would exhaust savings buffers within six months, while 55% of borrowers would not exhaust savings buffers for at least two years.
  • In terms of possible problematic borrowers, around 8% of borrowers would fully exhaust prepayment buffers within 6 months even with a severe cut to non-essential spending

From the above analysis, the RBA concludes overall, most borrowers are likely to be well placed to adjust their finances, with only a small share appearing vulnerable to falling into arrears.

What about those borrowers with fixed interest rates?

Uncertainty remains in regard to fixed-rate borrowers who now comprise around 35% of outstanding mortgage debt.

Around 2/3rds of these loans are due to mature by the end of 2023 and will have to be refinanced at significantly higher rates – the spread relative to market pricing would imply these borrowers seeing a 3-4 percentage point rise in mortgage rates which would equate to a 40% rise in minimum repayments.

The bottom line.

Recent RBA  modelling shows that overall the majority of variable-rate mortgage households are likely to be well placed to manage higher minimum loan repayments should the RBA cash rate rise by another 1% to 3.60%.

Households will meet higher minimum mortgage repayments by drawing down on savings buffers, or paring back on real non-essential consumption. 95% of owner-occupier variable-rate borrowers will still face a reduction in free cash flow, with such reductions being large for around 50% of borrowers.

At the aggregate, scheduled interest and principal payments are projected to rise to a level that is roughly on par with the total payments made prior to the start of the tightening cycle.

On the upside, it is clear that around half of variable rate owner-occupier households have large buffers (55% would not exhaust buffers for at least two years even with higher minimum repayments if they chose to maintain non-essential spending).

On the downside, 30% would exhaust buffers with higher minimum repayments within six months if they maintained non-essential spending at current levels. The scenarios also assume unemployment is unchanged.

About Michael Yardney Michael is the founder of Metropole Property Strategists who help their clients grow, protect and pass on their wealth through independent, unbiased property advice and advocacy. He's once again been voted Australia's leading property investment adviser and one of Australia's 50 most influential Thought Leaders. His opinions are regularly featured in the media.