RBA warns unwinding interest-only home loans may cause stress and impact on financial stability

| 20.02,18. 02:01 PM |

RBA warns unwinding interest-only home loans may cause stress and impact on financial stability

Photo: The RBA says falling house prices, coupled with investor debt, could harm the the building cycle. (Will Burgess, file photo: Reuters)

The Reserve Bank has warned that a wave of interest-only mortgages sold when standards were more lax and due to expire in the next four years may put borrowers into financial stress.

Speaking at the Responsible Lending and Borrowing Summit in Sydney, RBA assistant governor Michele Bullock said the investor loans, made before a tougher regulatory approach was imposed in the recent years, were being monitored closely to ensure they don't impact overall financial stability.

"There is still a large stock of housing debt out there, some of which probably would not meet the more conservative lending standards currently being imposed," Ms Bullock said.

Ms Bullock said the large proportion of interest-only loans set to expire between 2018 and 2022 was of particular concern.

In most cases the borrowers will simply move to principal and interest repayments as originally contracted, while others may choose to extend the interest-free period, provided that they meet the current lending standards.

However there was a smaller, but still significant group who could be trapped in a very tough spot.

"There may, however, be some borrowers that do not meet current lending standards for extending their interest-only repayments but would find the step-up to principal and interest repayments difficult to manage," Ms Bullock said.

"This third group might find themselves in some financial stress."

"While we think this is a relatively small proportion of borrowers, it will be an area to watch."

Threat to broader economy

Ms Bullock noted while the measures taken by APRA and ASIC to strengthen mortgage lending standards have helped improve the quality of lending over the past couple of years, the impact of falling house prices remained a big uncertainty in terms of overall financial stability.

This was particularly evident in the investor sector saddled with high loan-to-value ratios (LVRs) and little incentive to pay down debt.

On APRA and RBA figures, by the end of 2017 roughly 40 per cent of outstanding mortgages did not require principal repayments, while the mortgage-to-debt ratio had risen to 140 per cent from 120 per cent five years earlier.

"If housing prices were to fall substantially, therefore, such borrowers [with high LVRs] might find themselves in a position of negative equity more quickly than borrowers with an equivalent starting LVR that had paid down some principal," Ms Bullock noted.

Given investors were more likely to sell their rental properties in times of falling prices to minimise the their capital losses, Ms Bullock said this could quickly flow into the broader economy.

"This might exacerbate the fall in prices, impacting the housing wealth of all home owners," she said.

"As investors purchase more new dwellings than owner-occupiers, they might also exacerbate the housing construction cycle, making it prone to periods of oversupply and having a knock on effect to developers."

Owner-occupiers pose less of a risk

Ms Bullock had a far more sanguine view on the owner-occupier sector of the market, despite mounting levels of household debt.

"Looking only at owner-occupier households that have mortgage debt, the survey suggests that the median housing debt-to-income ratio has risen steadily over the past decade to around 250 per cent in 2016."

However, the median ratio of mortgage servicing payments to income has been fairly stable, remaining around 20 per cent in 2016, and a large proportion of indebted owner-occupier households are ahead on their mortgage repayments

While the level on banks' non-performing home loans have edged up in recent years, they are still at very low levels from an historic perspective.

"While debt levels are relatively high, and there are owner-occupier households that are experiencing some financial stress, this group is not currently growing rapidly," Ms Bullock concluded.

"This suggests that the risks to financial institutions and financial stability more broadly from household mortgage stress are not particularly acute at the moment."


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