Australians spending up on credit cards as prices rise
During the pandemic lockdown, Australians saved much more than they usually do and reduced debt.
The pandemic lockdown period was very difficult for many Australians, but at least it did have some positive side effects.
Not only did Australians save much more than they usually do – up to almost 20% of income – they also went on a debt reduction binge, stuffing money into offset accounts and even reducing dramatically their spending on credit cards.
Unfortunately, the rising cost of living and relative freedom to shop had dramatically reversed that picture, with RBA data showing four straight months of rising debts.
Petrol, rent and food have been rising fast – mortgages are next in line
All sorts of prices have been rising – some sharply – including petrol, electricity, food and rent.
And the big daddy of them all – mortgage payments – looks set for some hefty increases as well with the Reserve Bank hinting heavily that mortgage interest rates will rise this year – possibly several times.
Debt-accruing interest rose 0.3% in February to $17.4 billion, according to the RBA – although that is still 11.4% lower than the same month last year.
Still, the trend is becoming obvious now that debt has been rising for four months and as overseas travel opens up more, the use of credit cards is sure to rise with it.
While prices have been increasing fast, wages are yet to follow so the increasing credit card debt balance is acting as a bit of a shock absorber for the price hikes.
RBA warns increasing rates could crunch property by 15%
RBA numbers did suggest that the rise in interest rates could cause a lot of pain but that most of it would be contained to more recent borrowers with big mortgages.
The bank’s twice-yearly Financial Stability Review (FSR) found that house prices might fall as much as 15% if interest rates rise 2%, although it was generally positive that most households would be resilient in the face of higher rates.
“Most indebted households have benefited from strong growth in housing prices over the past year and, coupled with higher mortgage repayments in excess of scheduled requirements, the vast majority have accumulated substantial additional equity in their homes,” the report found.
Most loans in good shape but negative equity looms
Most loans are in fairly good shape too, with the RBA estimating that only around 5% of loans have an outstanding loan-to-value ratio (LVR) greater than 75%.
That compares to almost a quarter of loans at the beginning of 2020.
This means that for 95% of borrowers, it would take more than a 25% drop in home prices to send them into negative equity.
Reaching negative equity – where the borrower owes more than the house is worth – is often seen as a trigger for a greatly increased danger of default.
“The share of loans in negative equity is also estimated to be exceptionally low, at less than 0.25% down from 2.25% in January 2020,” the RBA found – although that situation could change rapidly if home values begin to reverse.
Rising rates will force repayments higher
Rising rates obviously lead to higher repayments for existing borrowers, except for those who locked in fixed rate mortgages.
Obviously, those on low fixed mortgages could also face a sizeable rate hike when their loan finally matures and needs to be re-negotiated.
The RBA analysis found that most borrowers should be able to cope with these higher repayments relatively comfortably, with 40% of borrowers already making average monthly repayments that would cover the increase in minimum repayments.
Another 20% would see their repayments rise no more than 20% from what they are currently paying, although one-in-five borrowers would be in the danger zone and see their minimum repayments increase by 40% or more.
Big debts are coupled with low savings
These more heavily indebted borrowers also tend to have lower accumulated savings and loan repayment buffers than the average mortgage customer, making them much more susceptible to default.
The average borrower has a buffer of around 45 months (at current interest rates) while the middle or median borrower is around 21 months ahead, well up from 10 months at the start of the pandemic.
However, of the quarter of borrowers whose repayments would rise by 30% or more, only around half have accumulated excess payment buffers equivalent to at least a year’s worth of their current repayments.
Recent buyers close to mortgage stress
That means households that are facing the biggest increase in repayments – usually relatively recent homebuyers – also on average have the smallest financial buffers saved up to cope with those higher repayments.
This is most clearly shown by the fact that for a 2% rate increase, the proportion of borrowers facing a debt servicing ratio greater than 30% would double from around 10% to just under 20%.
A debt servicing ratio above 30% of income is usually considered to indicate that borrowers are in mortgage stress.
Of course, using the credit card to keep up with mortgage repayments is a short-term fix but a long-term disaster, given how high credit card rates are.