RBA warns some borrowers will fall into arrears as higher interest rates bite

Rising interest rates and falling real incomes are already forcing households to reassess their finances, but the country’s central bank has said some borrowers will face a much higher burden than others.

The Reserve Bank of Australia’s latest Financial Stability Review, which is released twice yearly, laid out how it expects tighter monetary policy will impact borrowers.

In it, the central bank made clear that most households were in strong shape, but a number will be forced to tighten their budgets and many savings buffers built up over the pandemic period may also be exhausted.

The most vulnerable among the current crop of borrowers were those with low savings, low incomes and high debt relative to their income. Those who bought at the top of the property cycle will also be heavily impacted.

“If these households have limited ability to make other adjustments to their financial situation (e.g. by increasing their hours worked) and pressure on their finances continues, they could fall into arrears on their loan obligations,” the RBA said.

“Some may eventually need to sell their homes or may even enter into foreclosure.”

But the central bank acknowledged that the number of households at risk of falling into arrears is low by current estimates, and while it will continue to monitor for warning signs, a sharp jump is not expected in the coming years.

For that to happen, property prices would have to fall at a much faster pace than the RBA and other analysts are anticipating.

“A large decline in housing prices that results in negative equity for households, alongside further shocks to disposable income, would increase the risk that some borrowers default on their loan commitments,” the RBA said.

Offset and redraw accounts key to avoiding financial stress

The RBA notes that half of all borrowers currently on a floating rate will have their spare cash flows fall by at least 20 per cent over the next few years, including 15 per cent who will see their spare cash flows turn negative.

Another 40 per cent of variable rate mortgage holders will see a more moderate decrease in spare income of under 20 per cent after debt and basic living expenses have been met.

Whether borrowers will be able to weather the next two years with rates so much higher will depend on how robust their prepayment buffers are as well as their willingness to rein in non-essential spending.

Fortunately, around 35 per cent of all mortgage holders currently have more than two years’ worth of minimum payments sitting in their offset or redraw accounts, while almost 25 per cent have buffers of between three months and two years.

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The remaining share of borrowers has relatively little in the way of mortgage buffers, but the RBA notes that borrowers on fixed rates and investors that took out loans before 2021 comprise 40 per cent of this cohort.

Typically, homebuyers of this type aren’t able to make extra repayments without encountering penalties, so any savings buffers won’t be readily apparent and can overstate this group’s vulnerability.

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