Wake up Australia, we have a debt problem

@mickyyy - that will vary from lender to lender, and carded rates arent always the last word- you can obtain discounting at times, depending on a banks appetite for business at the time you are asking.

Last year you could have reasonably assumed that the P&I variable rate for investors would have been 0.5, 0.6 or at some lenders even as much as 1% higher than the P&I rate available for O/Occ borrowers , but those spreads are narrowing now that the banks have met their 30% quotas, and you are now typically seeing P&I investor rates only 0.2-0.5% higher than P&I rates for owner occupiers.

You could also have reasonably assumed that any form of discounting for investor debt - whether IO or P&I- was basically not available.... but today there is some appetite for pricing of investment debt , although its very much a case of timing.... a few weeks ago you'd have been able to get pricing from STG and Westpac that you cant get today, but similarly you;d be able to get pricing at CBA today that you couldnt have a few weeks back....

What I modeled in the previous post was an investor P&I rate of 4.5%, as that rate ( or close to it) should be reasonably accessible / available to investors from most lenders these days. You may be able to do a little better depending on lender and timing.

So we have a situation where the price of variable investment P&I debt is falling a little bit , as is the price of variable investment IO debt, and this is a result of the spreads narrowing.... but what hasnt changed is servicing calcs....

 

The FSB review came out a few days ago. Has a great insight into the regulators thinking into the issue. Again, there's an obvious failure to accurately attempt to quantify the problem. While data may be difficult to obtain, the regulators should be able to model this out with some tech.

Clearly the RBA recognise that this is a major risk. They're just not sure how big the problem is and have dressed over it as "The share of borrowers who cannot afford higher P&I repayments and are not eligible to alleviate their situation by refinancing is thought to be small".

With the right data, they can work out how big this risk really is.

1. Work out stock of IO loans and when they mature - they've done this part, quantifying an average of $120bn.
2. Work out stock of IO loans originated that will pass servicing in today's lending market - they have no idea.
3. Work out stock of IO loans originated that will pass servicing with extreme non-bank lending options - they have no idea.
4. Calculate number of households/size of debt that won't be able to refinance. This gives a picture of the total size of debt that will have the repayment increase.
5. Try and correlate this data with pre-payments and stocks of buffer (this part may be difficult).

It won't be perfect as there's no real way to work out how households have changed over 5 years (for better or worse), but it'll be a far better indication that 'thought to be small'.

IMO there's serious money to be made here by someone who can work this out. Some serious data crunching will bring to light a richness of information about one of the biggest risks to Aussie household debt.

It'll at the very least provide some insight into potential consumption crunches, house prices, etc. Running a brokerage, we see the individual data points on a daily basis, its quite common to see borrowers who fall into the 'trouble all round' basket. No real financing options to extend, no buffers and those that are biting their nails hoping options open before being forced to sell.

 

@Redom nice post

I have been running my own numbers and 90% of people max out there borrowing capacity from 3 plus years ago who have not had a pay increase of 20k or paid down there debt by 200k wont be able to refinance, this is based off 1m borrowing. Everyone I know that's across many industries have not had any pay rises in the last 3yrs.

I would say most cant refinance and actual repayments will increase by 20% and they will have to tighten there belts, some will eventually sell but as always the home or investment is the last thing to be sold

 

Surely we are due for 40-50 year loan terms?

With technology advancements, especially what is happening in the medical sector we are almost all certainly going to be living past 100 and working until we are 80+.

30 year loan terms are archaic for today’s society.

 

Didn't seam that long ago when they were only 20 year loans.

 

Few people ever fully use the 30 years anyway. Huge number sell up, refinance or pay it off within 7 years or less.

 

I cant imagine working in your 80’s

Where’s me zimmer frame

 

Agreed that most people are nomads and move around a bit with their home loans.

My biggest concern about the long term loans is the rather uncertainty in the labour market. I think the days of people working for the same employer from start to finish is rather slim and roles seems to have a self life. There are more restructures happening in organisations and rebranding of job titles. I end up telling family and friends that I have no idea what my job title is as it keeps changing!

 

@Redom I think this is a great post. You touched on some concerns I have been having. Curious to see what you have to say about the current state of Australian debt? Is the 1% drop since you posted this enough to quell your concerns about debt? It's mathematically has made it more serviceable, but for prices to rise as you have been suggesting, we will be back in much the same situation as your original post.

 

This post is a fair bit old, but was timely then. The problem isn't the % of household debt, this is a macro measure that tells one part of the story, but is far to macro to provide any meaningful conclusions. Answering how much debt can Australian's afford is really where you begin to get some better answers, rather than how much debt do we have.

Its also the best way to work out how 'much is too much'. If you allocate capital perfectly and ensure the right households carry the right debt, then there's scope for much much much more debt per household. I.e. most households are not anywhere near their maximum debt serviceability limits. This makes sense - people generally don't want to carry maximum debt amounts.

Since this debt problem was posted about, the stock of IO loans has dramatically fallen from around ~40% to <25% today. That is, 15%+ of all mortgages have converted to P&I inside ~2 years. That is a whole lot of mortgages across the country. Prices also fell ~10-15% in two cities that carry a lot of the debt burden. Also, points 3-5 about potential solutions came into play. In January this year, I also wrote a post about how lending changes were coming via rate cuts/assessment rate changes. These are now in play, meaning that the same debt is more serviceable today. The price falls also show partly why regulators have intervened so strongly...they simply can't allow a debt problem to be in place and prices to fall significantly. This will extrapolate a problem much further and very real tangible effects will be felt if people cant repay loans and are in negative equity positions. Banking would be in trouble if it's widespread.

That initial problem that was created has now gone away. This is pretty standard with debt cycles. Usually debt problems originate during the upswing phase, i.e. when credit growth is running fast. Australia took a bit of a hit through the transition too - consumption is down, house prices have fallen, construction is down, etc etc.

We're now at the other end of the debt cycle. Well and truly at the beginning of an upswing now. It will last quite a while. The changes that they've made mean there's a completely different setting that allows for greater debt take up. This is the part that is now true: Australian's can afford more debt than they carry again. That is, affordability is back. Sydney just recorded its fastest growth in 31 years! If you're on the ground going to auctions, you'll know its not slowing down anytime soon either (buyers are lucky to be buying at 2017 peak prices now in inner rings). Strong population, 2 years of nominal wage growth, strong jobs growth over a few years, price falls & interest rate cuts & higher borrowing powers mean that this is now the case. This may sound crazy given the dizzying prices people pay.

I suspect its possible in 2-3 years there'll be another debt problem. The most obvious one isn't likely to be interest only. It'll be about 'higher interest rates are coming, can Australian's handle it'? If credit growth explodes and prices are +30% higher, I suspect the answer is no & there'll be a deleveraging cycle again.

 

This is certainly an issue that has the potential to pop up down the road... Essentially, with one hand the RBA and APRA have , through a combination of rate cuts and assessment rate changes, provided existing and new borrowers with 10, 15% or even 20% more capacity and also provided existing borrowers who arent doing any more borrowing with much lower repayments. This eases the P&I shock on investors who have rolled to P&I recently, or about to roll to P&I, by a significant amount , but it also builds future P&I shock into the system for those now gearing up to their new maximum capacity , 5 years down the road. So yeah, very good chance we end up back where we were 6-9 months ago, in @ 5 years time, but with 10-15 or 20% more debt .... except next time the regulators wont have anything left to give, except a return to "actuals" . That would potentially kick the can another 5 years down the road I guess .... so potentially it may end up being 10 years before they reach the end of the road on this...be back to square 1 but with much higher levels of debt and DTI ratios and P&I shock than the system can handle, and we have an almighty pile up of P&I shock..... but then again, 10 years could also allow for some wage growth to counterbalance it. Doubt it though....

I think the cash rate reductions could have been done without any relaxation of assessment rates, or at least a more modest relaxation to say, 6.25% for example..... It would have been a safer way to go about things in my view. It would have provided ample reduction in repayments for all, but curtailed a debt binge. There is now some serious risk being built back into the system for 3,4,5 years away . Time will tell if it is a problem or not. But I suspect it will be.

 

I think they'll control any IO lending bounce back, so I really doubt we'll see the same debt issue pop up in a few years. I.e. if there's a significant ramp up in IO debt with these assessment rates, APRA will be all over it and it won't take 12-24 months to implement this time. Stock of IO debt at ~20% is pretty safe (its arbitrary figure though).

One of the most interesting things about allowing assessment rates to get to around 5% (probably this time next year) is that APRA/RBA are suggesting that rates won't climb here for a long long long time. If they believed mortgage rates could be at their 2014 levels again in their short to medium term horizon, they wouldn't allow mortgages to be stress tested at such a low benchmark.

Makes sense I guess, the market doesn't really believe Aussie rates will rise much over a 10 year period anyway.

 

I do think it's pertinent to point out the makeup of IO loans expiring in 2020. Most bought during peak.

 

@Timb89:

• ~ Half have already converted.
• The other half, only a portion will want to continue on IO.
• With the lending changes & competitive/deep lending market, 80-90% of the other half will have options at lower rates than they originally got them for. I.e. they will need to pass lower hurdles than they originally did. They will be on lower rates too than the origination rates.

I.e. now there's nothing unusual about 2020 and IO expiries. It's the same as every other year where IO's expire all the time.

 

Never let cold hard facts (even when presented in a graph) come in the way of pushing a doomsayer narrative..!

The graph apparently shows a tiny fraction of loans during peak (2017) maturing in 2020. Almost 90% of those expiring in 2020 comprise of loans originated in 2013-2015 period, thereby with 'significant equity' by the time they mature (see the colour spread)...

Try something more creative mate - as is you are pushing it uphill against the strong tide and seem to be clutching at the straws...

 

In my experience - and I work almost exclusively with investors - it's very few people who can't refinance their loans in some capacity.

Much, much more common is that people want to move but can't due to valuations...especially here in Perth.

 

Yes it seems like only yesterday commercial loans were set for 5yrs ..hang on it was yesterday the commercial loan was set for 5yrs! :-(

 

Very pleased with the change to 15 years