Indebted households with only small buffers risk their mortgage loans going into arrears if labour market dislocations continue due to COVID-19, the RBA has said.
Many Australian households who do not have significant financial buffers will find their finances under strain due to the measures implemented to contain the coronavirus, the central bank has warned.
In its April 2020 Financial Stability Review, the Reserve Bank of Australia (RBA) reiterated its stance that the level of household debt and higher house prices are enduring risks for the Australian financial system.
In the period ahead, as Australia faces the economic shock of the coronavirus pandemic, the RBA has warned that many households will struggle with their finances and mortgage payments.
While some households may be able to draw on significant financial buffers, including substantial mortgage prepayments, the RBA said many highly indebted households would have only small buffers.
These households would be more vulnerable to lost income.
“Repayment deferrals (‘holidays’) being offered by the banks and the government’s recently announced wage subsidy should both help avoid large increases in arrears,” the RBA said in its review.
“More generally, tightened lending standards over the past five years or so have improved the quality of outstanding household debt, while government income support policies and access to superannuation balances for the worst-affected households will cushion falls in household income.”
Most households entered this challenging period in good financial health, with surveys showing most households had enough liquid assets to cover basic living expenses and current obligations, such as mortgage and rent payments, for three months.
Households with mortgage debt usually had sizeable liquidity and/or equity buffers. Among these borrowers, over half of these loans had enough payments to service their loan repayments for at least three months.
However, the RBA stated there were certain segments of vulnerability before the pandemic, with some households having less liquidity to manage reductions in income.
“Surveys indicate that about one in five households only have enough liquid assets to get from one pay period to the next,” the RBA warned.
“These liquidity-constrained households are typically young, twice as likely to be renting and twice as vulnerable to unemployment compared with other households.”
Among households with mortgage debt, just under a third of mortgages have less than one month of prepayments, and about half of these are particularly vulnerable to a sudden and sharp drop in income.
Those households with limited liquidity buffers are much more likely to report facing financial hardship regardless of their age, income or labour force status.
For those with mortgage debt, a household member who loses their job or has their working hours reduced typically face greater financial strain.
The RBA warned that if labour market upheaval and associated debt serviceability issues prolonged, it could result in more mortgage loans entering arrears.
“Analysis based on loan-level data and historical relationships indicates that, for every one percentage point increase in the unemployment rate, the mortgage arrears rate increases by about 0.8 percentage points,” the RBA said.
“In response, the major banks have announced they will allow loan repayments to be deferred for up to six months to help home owners having difficulty meeting repayments.”
Renters don’t pose direct risk to banks
More than one-third of renting households typically report in surveys they have experienced financial stress in a given year, such as difficult paying bills or skipping meals.
The most vulnerable are those facing unemployment risk such as casual workers and those in industries most affected by the coronavirus containment measures, such as accommodation and hospitality services.
These workers are more likely to rent and more likely to have liquidity constraints.
However, increasing financial stress among renters does not pose direct risks to the banking sector because these households usually hold little debt.
“But they pose indirect risks if they have trouble paying rent and their landlords in turn have trouble making their own debt repayments,” the RBA said.
“Mortgage repayment deferment by lenders should reduce these risks for now.”
As part of the measures to cushion the blow on the economy from the coronavirus pandemic, governments have agreed to a moratorium on evictions for those tenants unable to pay rent due to a loss of income if they have lost their jobs.
[Related: Commercial rent relief code revealed]
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