This is the mortgage ‘ring of fire’
SUBURBS between 30-40km from city CBDs are most at risk of falling behind on their mortgages despite the high share of investment and interest-only loans posing a risk in inner-city areas, a new report warns.
Moody's analysts William Chung and Ilya Serov crunched the numbers to find mortgage delinquencies and defaults were higher in outer suburbs of Australian cities than inner-city areas, due to the lower average incomes and higher loan-to-value (LTV) ratios.
"Our analysis shows that in Australian capital cities, the share of mortgages that are at least 30 days in arrears averages 1.1 per cent in areas within 5km of CBDs, compared with 1.9 per cent in suburbs 30-40km from CBDs," they wrote in a report on Wednesday.
"Mortgage LTV ratios are higher on average in outer areas than inner-city areas, reflecting the lower average incomes of people in outer suburbs.
"People on lower incomes have less capacity to make mortgage repayments above the scheduled minimum payments, which means loan amounts are paid down slower and LTVs remain higher. Higher LTVs increase the risk of default and mean there is less equity in properties to absorb losses if defaults occur."
That doesn't mean CBDs are out of trouble.
In Melbourne, Brisbane, Adelaide and Perth, delinquency rates in suburbs closest to the city centre were slightly higher than those a little further out, reflecting the high share of mortgages on investment properties.
"For example, in suburbs within 5km of the Melbourne CBD, delinquent investment loans account for 57 per cent of all mortgage delinquencies," the report said.
"In suburbs within 5km of the CBD in Sydney, Melbourne and Brisbane, at least 50 per cent of mortgages are extended for investment purposes. There is also a high share of interest-only loans in these areas.
"In the event of a prolonged downturn in house prices, mortgage delinquencies and defaults could increase in inner-city areas with a high share of investment and interest-only loans, though in general we expect delinquencies and defaults to remain higher in outer suburbs."
The report warns that housing investment and interest-only loans have "generally performed well over recent years, given benign economic conditions and rising property prices".
"However, a large number of interest-only mortgages are due to convert to principal and interest loans over the next two years, which will increase the risk of delinquencies," it said.
"When interest-only loans convert to principal and interest, borrowers have to make higher monthly repayments, which can lead to delinquencies.
"In addition, the performance of investment and interest-only loans is more sensitive to housing price declines than owner-occupier and principal and interest loans, because borrowers rely on price gains to earn a return on their investment.
"Falling housing prices can also hamper borrowers' ability to refinance such loans or extend interest-only terms."
The total Australian mortgage market as of November 2017 was $1.6 trillion, with $1.07 trillion issued to owner-occupiers and another $560 billion to investors, according to the banking royal commission background paper.
The average residential loan was $264,000, compared with $347,000 for interest-only loans and $314,000 for loans with offset facilities.
According to Standard & Poor's estimates, based on residential mortgage-backed securities data, only 1 per cent of the total value of "prime" mortgages were more than a month in arrears as of February this year.
Prime mortgages are those where borrowers have a high likelihood of repaying their debt. Of those where borrowers have a lower likelihood of repaying - referred to as "nonconforming" or "subprime"- 3.4 per cent were in arrears by a month or more.
"This figure had dropped substantially since 2007," the paper said.
"These values dropped further when considering loans that were 90+ days in arrears. Only 0.6 per cent of Australian 'prime' mortgages were 90+ days in arrears, and around 1.5 per cent of Australian 'nonconforming' mortgages were 90+ days in arrears."
House prices across the country fell by 3.7 per cent in the year to September, the fastest decline since 2012, CoreLogic figures show.
Sydney and Melbourne are now 6.2 per cent and 4.4 per cent down from their respective peaks last year, with experts tipping at least another 10 per cent to go.
Price falls, combined with out-of-cycle interest rate hikes by the major banks and record high levels of household debt, have reignited fears of a full-blown property crash.
AMP Capital chief economist Dr Shane Oliver has said a "crash landing" marked by 20 per cent plus falls is a "significant risk" but unlikely in the absence of much higher interest rates or unemployment causing a wave of defaults and forced sales.
Digital Finance Analytics founder Martin North has likened Australia's situation to that of Ireland before the 2008 crash. Speaking to 60 Minutes recently, he raised the prospect of 40-45 per cent falls but said he put the likelihood of that scenario at one in five.
In an extreme case, prices could fall by as much as 80 per cent if the Australian Government allows the banks to fail, Mr North said in a recent video with economist John Adams.