Mortgage Stress: The Biggest Causes Of Mortgage Arrears and Default

Digital Editor · 20 June 2019
Households are suffering from a mortgage-stress hangover that is likely to worsen “for a bit longer” before recovery, the nation’s top financial stability expert has warned.

The Reserve Bank of Australia’s Financial Stability Department Head, Jonathan Kearns, said the recent rise in the number of borrowers who were behind in their mortgage repayments was caused by a unique mix of economic conditions, combined with the fallout from the heady days of home loan lending prior to the Financial Services Royal Commission.

Mr Kearns told the Property Leaders Summit on 18 June, this year that while 90-days plus housing arrears levels – the number of people who had missed a mortgage repayment deadline by more than three months – had risen, it was “by no means to a level that poses a risk to financial stability”.

However, he warned that the trend was one to watch closely as it was likely to continue.

“Several factors have been interacting to drive the rise in housing arrears,” he said.

The economy was also part of the story, he said, including the influence of weak income growth, housing price falls and rising unemployment.

“But they have not acted alone, interacting with earlier weaker lending standards, and the more recent tightening in lending standards.”

He said overall strong lending standards, and as long as unemployment remains low, arrears rates should not rise to levels that pose a risk to the financial system or cause great harm to the household sector.

What is “arrears”?

Borrowers start receiving arrears notices from banks when they miss a scheduled payment. Mr Kearns is referring to recent figures showing the number of people who were more than three months past their “pay by” date.

That length of time is significant, as a mortgage default – where the bank steps in and takes formal action against the owner such as foreclosing the mortgage and forcing the sale of the house – typically happens when borrowers fall 90 days or more behind in their repayments.

Why do people fall behind in mortgage repayments?

Mr Kearns said there were many reasons why borrowers fall into arrears, almost all of which involve a fall in income or rise in expenses – or both.

Some common reasons for this include:

  • Ill health
  • Losing your job
  • Divorce or separation
  • Weak house prices
  • Large increases in interest rates
  • Borrowing more than what you can really afford

Mr Kearns said there would “always be some borrowers who fall into arrears”, due to unforeseen personal circumstances, but a weak housing market where values are falling can make it hard for borrowers to get out of arrears by selling their property.

“Conversely, large increases in interest rates, say to slow an overheating economy, can also contribute to rising arrears,” he said.

“Banks’ lending standards also play a role in arrears. And it is important to note that economic conditions and lending standards interact.”

Mr Kearns suggested that some people who can’t really afford their home loan may be able to keep up the repayments in good economic conditions, and only fall into this situation when an economic downturn hits.

Australia has recently been through a period where lending standards were low, as highlighted by the recent Financial Services Royal Commission, during which several lenders were criticised over their loan approval processes. The Royal Commission found that some banks had loaned money to people who were not likely to be able to pay it back.

Why it matters?

When banks loan money, it’s a calculated risk: does the borrower’s capacity to pay back the loan and the current and the projected value of the property stack up? The bank also covers itself for the risk of failure, making a judgement about how much it could recover if it was forced to sell the property due to the borrower not being able to pay back the loan.

Right now, house prices across many parts of Australia are on a downward slide and, although some analysts say these falls could be slowing, this means the value of a bank’s asset base – how much they could get if they sold all their mortgaged properties – is also falling. There is less ‘risk wiggle room’ for the bank.

“Mortgage arrears can be associated with significant personal trauma for borrowers,” Mr Kearns said.

“They also point to a rising risk to the financial system, as housing loans are 40% of banks’ assets. If the value of the property backing a particular loan exceeds the value of that loan, then arrears won’t have a big impact on banks’ profits or capital.

“But with falling housing prices, the potential for banks to experience losses increases. So, on several fronts, this is an important issue.”

Be alert, not alarmed

There’s no need to panic, Mr Kearns said. While arrears are the worst they have been in almost a decade, he says that in global terms, Australia is still doing OK.

“The share of banks’ housing loans in arrears is now back around the level reached in 2010, the highest it has been for many years. But arrears are still well below the level reached in the early 1990s recession,” he said.

“While the increase in arrears and its level is notable, the rate of arrears in Australia is still relatively low internationally, and in an absolute sense … arrears are lower in Australia than in many other advanced economies.”

He said it was important to note that more than 99% of home loan borrowers were keeping up with or ahead of their repayments.

What to do if you are facing mortgage stress

The most important thing you need to do if you should consider if you are in mortgage stress is to talk to your lender. If you tell your lender you are having trouble meeting your monthly repayments, they are obligated by law to assist you in setting up an affordable repayment plan.

If your lender is already taking legal action, consider getting legal advice so that you know what your options are. You can get free legal advice from the centres listed on the MoneySmart website.

Take this quick Mortgage Stress Test

As a homeowner, do you:

  • Pay more than 30% of your pre-tax salary to your home loan?
  • Pay interest only on your home loan?
  • Struggle to find money for utility bills?
  • Pay those bills with your credit cards?
  • Pay only the minimum due on your credit cards?
  • Regret buying that fancy car with the balloon payment at the end of the car loan or lease?

If you answered ‘yes’ to the majority of these questions, mortgage stress could be an issue for you and it might be time to look at strategies to help ease that burden. Taking control of your finances now could save you heartache in the long run.

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