The average variable home loan rate in Australia has fallen from 8.3% to 5.1% in the past ten years, enabling households to borrow more and drive house prices higher. Despite higher levels of household debt, Australians’ level of mortgage stress is quite low. But what if interest rates go up? Ashley Burtenshaw from Gryphon Capital Investments addresses this question in the video and edited transcript below.
- House prices are highly correlated with interest rates – as rates go down, house prices go up,
- The ratings agencies have found that arrears rates are low,
- Provisions for bad loans remain low with the banks,
- As we currently stand, mortgages are quite affordable,
- Interest rate ‘buffers’ are required by APRA when assessing loan serviceability, these should help to protect both lenders and borrowers in the event of higher rates,
- Gyphon’s analysis, based on nearly 20 years of data, suggests that mortgages holders should be able to withstand higher rates.
Are you concerned about debt serviceability in Australia?
It comes down to capacity to pay. Our analysis leads us to looking at the housing market and interest rates. It shows that house prices are highly correlated to interest rates; so, as interest rates come down, house prices go up. That’s no surprise to us.
Now that interest rates have gone down so far, the market is starting to get concerned about interest rates rises. What is the ability for those borrowers to continue to pay given the amount of debt they've taken on?
Currently, when you look at interest rates, it's quite affordable. That's being backed up by firms like S&P and Moody's, who rate these types of vehicles. They're saying that the mortgage arrears rate, the borrower that's in difficulty, is actually quite low.
When we look for other evidence, we're looking to the banks for any increases to their loss provisions on their balance sheet. What we haven't seen is stress, and that's because rates are low. So, yes, with mortgage rates at this level, do they have capacity to pay? Yes. If rates start to rise, we believe we'll start to see that uncomfortable rise in delinquencies and arrears. Provisions for doubtful debt will start to increase on the banks' balance sheets. But where we are today, there is capacity to pay.
Can borrowers in Australia handle higher rates?
In Australia, the regulators have been ahead of the game and have sought to address this issue. When a borrower goes to get a mortgage, the bank has to assign an assessment rate. The lender looks at the borrower and says, "Okay, at what rate am I comfortable lending to you, considering the risk that I'm taking?" Because the assessment rate is a function of interest rates, the regulators stepped in to say, "If the rates start to move higher, because we have variable rate mortgage, we need to look after the borrower and make sure that there's a sufficient buffer built into their mortgage rate." It's assessment rate plus buffer.
We believe that the new loans getting written after this is put through will be able to perform. However, proof will be once rates start increasing, what will be the impact? We think that it will be increasingly difficult for the market to assess this. However, we believe in the history of losses and the delinquencies since we've been managing it. Our data indicates that the market will be able to withstand an increase in interest rates.
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My concern is the high percentage of housing loans approved on interest only basis? Westpac had up to 50% of its book interest only but like all the Banks has reduced this figure following pressure from APRA. If borrowers cant payoff principal and interest on a loan they shouldnt pretend to be homeowners. Any loans have to be assessed on a what if basis covering different interest rate scenarios surely.
Justin Bratling of Watermark Funds wrote a report warning of a housing bubble but concluded, like this article, that households will be able and will do everything they can to repay given our local laws. The place where the real pain will be felt will be in business lending according to Bratling. Obviously this is because mortgages will be sucking up all the consumers cash. Retail (our biggest employer) will be a bloodbath. There is no free lunch. Interest rates when debt levels are so high cannot go up without any serious repercussions. When are people going to stop pretending otherwise?