The Reserve Bank of Australia (RBA) Financial Stability Review (FSR), released earlier today, contains some interesting data on household debt levels and household’s preferences on how they service this debt.
The FSR shows that overall debt levels, which are 148% of disposable incomes currently, remain near historical highs having barely moved since 2006, when they peaked at 153%. However, due to lower interest rates, this debt has become easier to service.
The more prudent approach to finances can also be seen in households’ reduced appetite for taking on additional debt since the financial crisis (Graph 3.12).
Household credit growth has been slower in the past five years – at an average annual rate of around 5½ per cent – than in the 20 years prior, when it averaged around 13½ per cent. Within household credit, personal credit has declined over the past five years, with a large fall in margin loans partially offset by modest growth in credit card debt. Growth in housing credit has also slowed over this period, to a current annual rate of around 4½ per cent despite a moderate pick-up in the value of housing loan approvals in the past few years. The slower pace of credit growth has been outpaced by income growth in the past couple of years, resulting in the household debt-to-income ratio falling slightly, to 148 per cent, after peaking at 153 per cent in late 2006. Real household disposable income growth has recently slowed a little, however, to 2 per cent over the year to the December quarter 2012. This modest growth in income, combined with the decline in interest rates and slower credit growth, has reduced the share of disposable income used to make interest payments to an estimated 9½ per cent in the March quarter 2013. Household indebtedness and gearing are still around historically high levels though, so from the perspective of their financial resilience it would be preferable if households maintained this more prudent behaviour.
The RBA also implictly explains why housing finance commitments have, until recently, been rising whilst mortgage credit growth continues to fall. The answer is in the fact that households with pre-existing mortgages are taking advantage of lower mortgage rates to pay down their debt (partly offsetting new mortgage creation). These accelerated repayments, in turn, are improving household’s own financial stability by increasing their mortgage buffers – i.e. the amount paid in excess of their minimum required repayments.
Contributing to the slower pace of credit growth is the fact that many households have been taking advantage of the lower interest rate environment to pay down their debt faster than required. Mortgage buffers – balances in mortgage offset and redraw facilities – are now estimated to be equivalent to around 14 per cent of the outstanding stock of housing loans (Graph 3.13).
When interest rates fall, not all borrowers reduce their mortgage payments, resulting in an increase in prepayment rates. The increase in the rate of prepayment as a result of the decline in mortgage lending rates since late 2011 is estimated to have reduced the growth rate of housing credit by around ½ percentage point over 2012.
Measured a different way, in aggregate, households’ mortgage buffers are equivalent to around 20 months of scheduled repayments (principal plus interest) at current interest rates. This provides considerable scope for many borrowers to continue to meet their loan repayments even during a temporary spell of unemployment or reduced income. As with housing loans, households have also been paying off credit card debt; net repayments on personal credit and charge cards have been above average in recent years and balances on personal credit cards have also slightly declined since mid 2012.
While the aggregate lift in mortgage buffers is a good thing, it provides only a limited assessment of default risks. Since risks are at the margin, we would need to know the breakdown at different loan-to-value ratio (LVR) levels in order to know whether there are a significant portion of high LVR mortgages potentially at risk in the event of a major economic downturn.