Can your family survive if there is an interest rate rise?

Ross Greenwood speaks to Martin North from Digital Finance Analytics about how mortgage stress is causing people to eat into their savings and turn to credit cards to make ends meet.

Introduction: Can your family survive if there is an interest rate rise?

Ross Greenwood: For now the house prices are very much front and center of people’s attention right now. There’s a few things, there’s been a number of forecasts out. Morgan Stanley saying they believe that house prices in Australia remain vulnerable.

There’s been concern about Brisbane apartment prices, in particular. With the number of apartments built that the glut will go on for as long as five years, some have suggested. Now, there’s other aspects of this, also, because think about the Royal Commission in to banking.

Even today Brian Hartzer, the Chief Executive of Westpac, indicated that he believes it might be time to start dismantling the way that mortgage broker commissions are paid. It might end up being that you as a consumer, rather than having a commission come out which is paid by the banks to the broker, effectively you may pay the broker directly.

Almost like you pay your accountant. Now your financial planner used to have commissions themselves or indeed your lawyer. I wonder whether that would for individuals and whether you would be prepared to pay.

Then you get to another aspect of this and that is about the big mortgages that people have taken on. In particular in our biggest capital cities, where the prices have risen so fast over the past five years or so.

A new report which has come out by Digital Finance Analytics today indicates that it believes that mortgage stress is continuing to rise, especially as wages growth has stalled right throughout Australia.

That’s actually documented where the hardship is being felt most and indeed by whom. In terms of social demographics and also regional demographics. Martin North is the boss of Digital Finance Analytics, he’s on the line right now. Many thanks for your time, Martin.

Interview with: Martin North, Digital Finance Analytics

Martin North: Hello.

Ross Greenwood:  So, the research that you have done, who do you believe is most exposed right now?

Martin North:  It’s pretty broad based there, Ross, because the numbers big, 956,000 households, that’s nearly 30% of all borrowing households. If you look at it in terms of the absolute number then it’s what we call the young growing families and the disadvantaged fringe.

Those people who’ve bought relatively recently, with young families, and those in the urban rings around our major cities. For example, places like Liverpool and Campbelltown in and around Sydney.

We also see some more affluent households also being hit, because of course, they’ve got the biggest mortgages of all. Therefore they are most exposed to any changes in interest rates or any changes in income.

This is a problem that is touching lots of different types of households.

Ross Greenwood:  The things that I think about are while most families can find the work and have the work, we know 400,000 jobs give or take are created last year. That there is more work, seemingly, going around at this stage.

Except in the event of a shock which would cause significant unemployment over a very short space of time. Most people, though they’re under stress, seem to be coping. Would that be a fair statement?

Martin North:  Well, yes. At the moment jobs are there and so there is income coming in. I’d say that some of those jobs probably are paying less than they used to, that’s one of the things to notice.

The problem is that the costs of living are, essentially, continuing to rise. Things like school fees, electricity bills, all that sort of stuff. Mortgage rates are really low at the moment and we’ve actually seen quite recently a little bit of tweaking down for some people if they refinance.

It’s hair trigger, right, even a small increase in mortgage rates or a small rise in the cost of living will have a significant impact. I don’t think wages are going to go anywhere up any time soon.

It’s the real sensitivity and, essentially, what we’ve now got is a situation where people are dipping into their savings to be able to continue to pay the bills and everything and putting more on credit cards.

Both those strategies are essentially not sustainable over the long term. Unless we start seeing incomes begin to rise, then this problem is going to get considerably worse. Even before interest rates change.

Ross Greenwood:  There’s another aspect of this that house prices are not rising in most of the major capital cities. Right now house prices are either flat or going backwards. Therefore that is almost compounding the hurt.

Even if these people wanted to get themselves out of their mortgage stress and decided to go back into the rental market they might sustain significant losses if they were try to sell their houses anytime shortly.

Martin North:  Yes, well, we’ve got this rather nasty situation you could end up with a mortgage that is worth more than the property value that you’ve actually got when you tried to sell. Of course, if you do sell in a fore sale situation the property value tends to go down in any case.

Now, if you look at what happened in Ireland and the US post the global financial crisis, a lot of people tried to sell and ended up selling at a loss and ended up with then a debt that they still need to pay.

You don’t walk away in Australia if you sell the property and have a net debt less, it still is with you. It still haunts you. If prices begin their journey and move further down, then more and more people are going to be finding it’s really tough to know what to do.

Do they sell? Do they and restructure and refinance? Do they just hopefully struggle through? I have to tell you that the struggle through strategy isn’t probably going to work because incomes aren’t going to rise.

I think trying to sell may be difficult for some people. This is beginning to get to the point where there are very few options for people.

Ross Greenwood:  Okay, you also say of that 956,000 households that you estimate now in mortgage stress, that there are some 55,000 households that risk a 30-day default within the next 12 months.

That’s where it becomes really serious. Can you just, for people, just define what you call mortgage stress?

Martin North:  Sure. The way we measure mortgage stress is we don’t use a standard proportion of income to pay the mortgage. No, they used to use 30% years ago, but really that’s no longer relevant because many people are well over the 30%.

We look at it in a cash flow basis. We look at the money coming in, money going out. Essentially if people have no wriggle room they’re in stress. If they are actually underwater, in other words, they’re actually receiving less in than they’re paying out, we put them in the severe stress category.

Then we model that over the next 12 months. What do we think’s going to happen? What do we think is going to happen, for example, for employment and for interest rates. Then we predict what could happen when people miss payments.

Effectively, missing a 30-day payment is the first sign of slipping into default. We think 55,000 households will risk that over the next 12 months. Many of those will go on, ultimately, needing to sell their property.

Ross Greenwood:  Of course, part of the reason why you do this is to actually look at the banks in particular, the lenders, to see how strong and how robust they are in the event that this number of people were to default on their loans over the next 12 months.

Martin North:  Well, that’s right. The absolute loss ratios at the banks is pretty low at the moment. It’s around 2.8 basis, which is a very low number. Actually, when you think where interest rates are actually now, those loss rates should be even lower.

We’ve already got a bit of a problem. WA, for example, is twice that. We’ve already got more issues over in the west coast. Essentially, if the loss ratios begin to move up then that’s going to start hitting the banks considerably.

At a time when they’re already under pressure from mortgage underwriting and all the other things that the Royal Commission touched on. This is now an issue that could actually begin into a question about the financial structure and stability of the banking system if things got considerably worse now.

This is an early warning sign. It may not happen but the writing is a bit on the wall now and if things go the way that we’ve been monitoring them for the last few years, then we are at a critical inflection point.

I suspect that we’re going to find things are going to get worse over the next two to three years.

Ross Greenwood:  Martin North, from Digital Finance Analytics has crunched the number on mortgage stress in Australia. If you’re one of those people give us a call.

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