RBA: Australian property market can withstand a 40% crash

RBA: Australian property market can withstand a 40% crash

The Australian property market could reliably withstand an ‘extreme’ scenario of dropping 40 per cent in value at a time of high unemployment, a discussion paper issued by the country’s central bank has found.

The paper, titled ‘How risky is Australian household debt?’, examined the risks posed by the housing market’s increasing indebtedness, the stress a strong downturn would place on the banking system, and the effects it would have on people’s everyday spending.

How would we cope with a dire economic scenario?

A scenario where property prices dropped by 40 per cent and unemployment rose to 8 per cent was simulated using detailed household-level data -- data that predates the COVID-19 pandemic -- to stress test the banking system and consumer spending.

“We believe this is an extreme but plausible scenario, which is broadly in line with the shock experienced by some countries during the global financial crisis,” the discussion paper said.

“...(It) is comparable to (property) falls experienced in countries that were heavily affected by the (global financial) crisis, including the United States (32 per cent fall), Spain (37 per cent fall) and Ireland (55 per cent fall).”

Due to the COVID-19 pandemic, Australia’s unemployment rate is forecast to hit double digits before settling at 7 per cent for a few years, according to the Reserve Bank of Australia, but government stimulus payments have been introduced to subsidise a loss of income for many.

The simulation aimed to identify the households that would throttle their spending and default on their mortgage repayments.

Well enough, it seems

Banks are well positioned to handle “a severe downturn in the economy”, the stress tests revealed.

“The main reason for this is that they have maintained strong lending standards: most of the debt is held by households that have significant equity backing their loans and that are less likely to become unemployed than others in a downturn,” the discussion paper said.

“Nonetheless, we show that these households could still significantly curtail their consumption in response to a severe recession, especially if they react more strongly to declines in housing prices than they do to rises.”

The paper noted spending fell by modest margins since the GFC, while household indebtedness rose.

Australian household debt has risen

Australia has high levels of household debt relative to many other countries, the Reserve Bank said, but the results of the stress tests were positive for two reasons.

The first has to do with income levels: although household debt is higher in Australia, so too is income levels. This, coupled with falls in interest rates and inflation, means households have more money to spend on servicing the debt, the discussion paper said.

The second concerns home ownership. The property market in Australia is privately owned -- between people, banks, and at times, businesses -- while in overseas countries, a ‘significant’ share of rental properties belong to the government and corporate sectors.

Interestingly, the discussion paper, which used data predating the COVID-19 pandemic, said its findings cannot explain changes that have occurred from 2015.  “(Our) model cannot explain the increase in debt over the past four or five years”, it said.

Key findings 

Three conclusions were drawn from the discussion paper.

The paper found it misleading to describe Australian households being more vulnerable than those overseas due to their higher levels of debt. Rather, it contends conditions in Australia make it easier for households to service greater debt.

The debt of households poses real management challenges for banks, the paper said. 

And in turn, this indebtedness would affect consumer spending in “a larger-than-otherwise fall”, rather than they are to result in defaults and bank failures.

The paper credited Australian banks and policies by the Australian Prudential Regulation Authority in “mostly (doing) a good job” in making sure credit is issued to the people who can afford it. 

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Learn more about home loans

How much debt is too much?

A home loan is considered to be too large when the monthly repayments exceed 30 per cent of your pre-tax income. Anything over this threshold is officially known as ‘mortgage stress’ – and for good reason – it can seriously affect your lifestyle and your actual stress levels.

The best way to avoid mortgage stress is by factoring in a sizeable buffer of at least 2 – 3 per cent. If this then tips you over into the mortgage stress category, then it’s likely you’re taking on too much debt.

If you’re wondering if this kind of buffer is really necessary, consider this: historically, the average interest rate is around 7 per cent, so the chances of your 30 year loan spending half of its time above this rate is entirely plausible – and that’s before you’ve even factored in any of life’s emergencies such as the loss of one income or the arrival of a new family member.

What are the pros and cons of no-deposit home loans?

It’s no longer possible to get a no-deposit home loan in Australia. In some circumstances, you might be able to take out a mortgage with a 5 per cent deposit – but before you do so, it’s important to weigh up the pros and cons.

The big advantage of borrowing 95 per cent (also known as a 95 per cent home loan) is that you get to buy your property sooner. That may be particularly important if you plan to purchase in a rising market, where prices are increasing faster than you can accumulate savings.

But 95 per cent home loans also have disadvantages. First, the 95 per cent home loan market is relatively small, so you’ll have fewer options to choose from. Second, you’ll probably have to pay LMI (lender’s mortgage insurance). Third, you’ll probably be charged a higher interest rate. Fourth, the more you borrow, the more you’ll ultimately have to pay in interest. Fifth, if your property declines in value, your mortgage might end up being worth more than your home.

What is mortgage stress?

Mortgage stress is when you don’t have enough income to comfortably meet your monthly mortgage repayments and maintain your lifestyle. Many experts believe that mortgage stress starts when you are spending 30 per cent or more of your pre-tax income on mortgage repayments.

Mortgage stress can lead to people defaulting on their loans which can have serious long term repercussions.

The best way to avoid mortgage stress is to include at least a 2 – 3 per cent buffer in your estimated monthly repayments. If you could still make your monthly repayments comfortably at a rate of up to 8 or 9 per cent then you should be in good position to meet your obligations. If you think that a rate rise would leave you at a risk of defaulting on your loan, consider borrowing less money.

If you do find yourself in mortgage stress, talk to your bank about ways to potentially reduce your mortgage burden. Contacting a financial counsellor can also be a good idea. You can locate a free counselling service in your state by calling the national hotline: 1800 007 007 or visiting www.financialcounsellingaustralia.org.au.

Does Australia have no-deposit home loans?

Australia no longer has no-deposit home loans – or 100 per cent home loans as they’re also known – because they’re regarded as too risky.

However, some lenders allow some borrowers to take out mortgages with a 5 per cent deposit.

Another option is to source a deposit from elsewhere – either by using a parental guarantee or by drawing out equity from another property.

Does Australia have no cost refinancing?

No Cost Refinancing is an option available in the US where the lender or broker covers your switching costs, such as appraisal fees and settlement costs. Unfortunately, no cost refinancing isn’t available in Australia.

Can I change jobs while I am applying for a home loan?

Whether you’re a new borrower or you’re refinancing your home loan, many lenders require you to be in a permanent job with the same employer for at least 6 months before applying for a home loan. Different lenders have different requirements. 

If your work situation changes for any reason while you’re applying for a mortgage, this could reduce your chances of successfully completing the process. Contacting the lender as soon as you know your employment situation is changing may allow you to work something out. 

Can I get a home loan if I am on an employment contract?

Some lenders will allow you to apply for a mortgage if you are a contractor or freelancer. However, many lenders prefer you to be in a permanent, ongoing role, because a more stable income means you’re more likely to keep up with your repayments.

If you’re a contractor, freelancer, or are otherwise self-employed, it may still be possible to apply for a low-doc home loan, as these mortgages require less specific proof of income.

Will I have to pay lenders' mortgage insurance twice if I refinance?

If your deposit was less than 20 per cent of your property’s value when you took out your original loan, you may have paid lenders’ mortgage insurance (LMI) to cover the lender against the risk that you may default on your repayments. 

If you refinance to a new home loan, but still don’t have enough deposit and/or equity to provide 20 per cent security, you’ll need to pay for the lender’s LMI a second time. This could potentially add thousands or tens of thousands of dollars in upfront costs to your mortgage, so it’s important to consider whether the financial benefits of refinancing may be worth these costs.

Is there a limit to how many times I can refinance?

There is no set limit to how many times you are allowed to refinance. Some surveyed RateCity users have refinanced up to three times.

However, if you refinance several times in short succession, it could affect your credit score. Lenders assess your credit score when you apply for new loans, so if you end up with bad credit, you may not be able to refinance if and when you really need to.

Before refinancing multiple times, consider getting a copy of your credit report and ensure your credit history is in good shape for future refinances.

I have a poor credit rating. Am I still able to get a mortgage?

Some lenders still allow you to apply for a home loan if you have impaired credit. However, you may pay a slightly higher interest rate and/or higher fees. This is to help offset the higher risk that you may default on your repayments.

I can't pick a loan. Should I apply to multiple lenders?

Applying for home loans with multiple lenders at once can affect your credit history, as multiple loan applications in short succession can make you look like a risky borrower. Comparing home loans from different lenders, assessing their features and benefits, and making one application to a preferred lender may help to improve your chances of success

Will I be paying two mortgages at once when I refinance?

No, given the way the loan and title transfer works, you will not have to pay two mortgages at the one time. You will make your last monthly repayment on loan number one and then the following month you will start paying off loan number two.

If I don't like my new lender after I refinance, can I go back to my previous lender?

If you wish to return to your previous lender after refinancing, you will have to go through the refinancing process again and pay a second set of discharge and upfront fees. 

Therefore, before you refinance, it’s important to weigh up the new prospective lender against your current lender in a number of areas, including fees, flexibility, customer service and interest rate.

Can I refinance if I have other products bundled with my home loan?

If your home loan was part of a package deal that included access to credit cards, transaction accounts or term deposits from the same lender, switching all of these over to a new lender can seem daunting. However, some lenders offer to manage part of this process for you as an incentive to refinance with them – contact your lender to learn more about what they offer.