RBA review warns on mortgage shock

The RBA has deep concerns about the property market, warning that many people could be forced to dump their homes.

Investment bank UBS has found one-third of interest-only borrowers are unaware they are not paying off their mortgage.

The Reserve Bank has revealed deep concerns about the property market, warning interest-only borrowers are vulnerable to “payment shock” and that many households could be forced to dump their homes onto the market.

In its twice-yearly Financial Stability Review, the bank also highlighted investor lending issues, including the number of investors who own multiple properties outpacing more modest property investment, with those owning five properties growing by 7.5 per cent in a single year.

In a stark admission of the heightened threat to financial stability amid endless increases in household debt and rampant property prices, the RBA will launch “top down stress tests” of the banking system, which will be carried out on top of the supervision from the Australian Prudential Regulation Authority.

It’s another layer of scrutiny on the banking system, which is being investigated by the corporate watchdog for possible breaches of responsible lending laws when interest-only loans are sold to customers.

APRA in March told banks to limit the sale of interest-only loans, which don’t require any payment on principal for a period of around five years. Investment bank UBS has found one-third of interest-only borrowers are unaware they are not paying off their mortgage.

The RBA said in its review that interest-only borrowers remained more indebted throughout the life of the loan than other borrowers, which made them “more vulnerable to higher interest rates, reduced income, or lowering house prices”.

“Such households are also more vulnerable to ‘payment shock’ due to the increase in repayments following the end of the interest-only period of the loan,” the central bank said.

The warnings came as Citi analyst Craig Williams suggested interest-only mortgages could be the country’s “Achilles’ heel”, in part of a wide-ranging report on the risk presented by Australia’s high rate of interest-only loans, which account for more than a third of all mortgages.

“Tighter application of responsible lending laws means that investors must now have a clear debt repayment plan, although for many prevailing interest-only borrowers this does not exist,” Mr Williams said. “The large levels of debt outstanding by borrowers aged in their 50s and 60s means many investors will need to sell property to discharge their debts.”

The RBA said the “key risks” in the local financial system stemmed from household borrowing. Household debt has continued to climb amid record-low interest rates, recently touching a debt-to-income ratio of 194 per cent — one of the world’s highest. “Higher interest rates, or falls in income, could see some highly indebted households struggle to service their debt and so curtail their spending,” the RBA said.

But the RBA stressed moves by regulators to tighten standards for housing loans are working and have helped ease Australia’s overheated property market.

“In Sydney and Melbourne, housing price growth has slowed and auction clearance rates have fallen,” the RBA said.

“A range of factors have contributed to the slowing, including increased housing supply, higher interest rates for some borrowers and an apparent reduction in demand from foreign buyers.”

Most indicators of household financial stress remain benign, it said, although there would be concern if households experience large declines in income. The central bank again highlighted weak conditions in Brisbane’s apartment market, where an increase in supply has resulted in falling prices and no growth in rents.

However, there are few signs that buyers are having difficulty completing settlements on purchased properties so far, it said.

The Reserve Bank also noted some concerns about the non-residential commercial property segment, saying activity has been subdued in many markets other than Sydney and vacancies are high, especially in Perth.

It also points out that the tightening of lending standards by major banks could lead to riskier lending migrating to the non-bank sector.

Overall, Australia’s financial system remains in a strong position and its resilience to shocks has increased over recent years, the central bank said.

Additional reporting: AAP