RBA's 'very blunt tool' pushing more borrowers to the brink

A new RBA report says the proportion of borrowers who are more than 30 days behind on their mortgage repayments has risen over the past two years as interest rates have increased.

The central bank pointed to “challenging macroeconomic conditions” as a key driver of the increase in arrears, including higher interest rates and declining real wages.

High interest rates trigger rise in home loan arrears

Housing loan arrears rates, owner occupiers. Source: RBA

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Home loans are classified as in arrears when borrowers miss their minimum scheduled payment, but are still expected to return to fully servicing their loan. 

This differs from a default, which is when a borrower is no longer expected to fully service their loan.

The recent rise in arrears comes from low levels, having bottomed out prior to the current rate tightening cycle. 

“While arrears rates remain around pre-pandemic levels, banks expect them to increase a bit further from here,” the report stated.

Arrears rates for riskier loans rise sharply

Source: RBA. Shaded area indicates structural break.

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Rates of arrears are higher for “risky loans” including borrowers with higher loan-to-value (LVR) and loan-to-income (LTI) ratios and lower-income borrowers, according to the report in the RBA’s quarterly Bulletin publication.

The proportion of high LVR loans (above 80%) more than 90 days behind has jumped sharply to about 2.5%, rising from less than 1% in late 2022.

“Highly leveraged borrowers have been most likely to fall into arrears since 2022, consistent with their generally higher arrears rates and greater vulnerability to challenging economic conditions,” the report by RBA analysts Ryan Morgan and Elena Ryan stated.

Higher interest rates have caused demand to slow, with borrowers forking out a larger proportion of their income on mortgage repayments. Picture: Eugene Hyland

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People who borrowed when interest rates were higher, as well as recent first-home buyers, were also perceived to have a greater likelihood of falling behind, the report said.

“Looking ahead, household budget pressures are expected to remain elevated for some time but to ease a little as inflation moderates further.”

Despite the tough economic situation, the RBA still expects the majority of mortgage holders to continue paying off their home loans.

“Nearly all borrowers are expected to be able to continue servicing their debts even if budget pressures were to remain elevated for an extended period,” the report stated.

RBA cash rate ‘a very blunt tool’

The RBA has increased the cash rate 13 times since May 2022 in a bid to bring inflation back to its 2-3% target range.

When the cash rate is increased, so too are home loan and savings interest rates, which is intended to discourage people from spending to help bring down prices of goods and services.

The Reserve Bank says “challenging macroeconomic conditions” are a key driver of the rise in home loan arrears.

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According to the RBA’s most recent Statement on Monetary Policy in May, raising the cash rate has caused demand to slow, given borrowers now need to contribute a higher share of household income towards loan repayments.

“The rise in household debt payments has put pressure on household budgets and contributed to the weakness in consumption growth”

The Consumer Price Index, a measure of household inflation, reached a peak of 7.8% in the December quarter of 2022, before easing to 3.6% by the March quarter of this year.

Inflation is expected to reach the 2-3% target range by late 2025, before settling at 2.6% by June 2025, according to the RBA.

Rates of mortgage arrears are higher for highly leveraged borrowers, according to the RBA. Picture: Getty

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PropTrack senior economist Paul Ryan said adjusting the cash rate had a “very uneven effect” across the economy.

“It can be a very blunt tool,” he said. “There's one one interest rate that affects all people in the economy and all parts of Australia at the same time.”

NAB chief economist Alan Oster said raising interest rates to bring down inflation was working, but the RBA was “trying to tread a very thin line” to slow the economy without “crunching” it.

“The cash rate adjustments they've made have started to slow inflation,” he said.

“You could say at the top end of town, [it’s had] no impact.”

“But the net effect has actually had the impact they wanted and it’s slowed the economy big time.”

Housing affordability squeeze

Another result of higher interest rates has been diminished housing affordability, Mr Ryan said.

“Mortgage rates are the key input into housing affordability,” he said. 

“Higher mortgage rates really stifle borrowing capacity in the housing market in particular.”

Despite borrowing capacities reducing by about 30% since rates started increasing, housing prices have continued to rise across most of the country. 

The national median home value reached its highest point ever in June, with population growth and a slowdown in new construction concentrating demand for available homes.

“At the moment we're seeing the toughest affordability conditions in at least 30 years,” Mr Ryan said.

“The last time we saw really strained affordability conditions was in about 2008 which was, no surprise, the last time we had very high mortgage rates.”