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Is financial hardship and distress on the rise?

Some challenging economic conditions have put pressure on already-stretched household budgets, in some cases pushing customers into financial hardship and distress. It’s a key issue in our industry, exacerbated by the recent falls in global share prices and increased short-term US interest rates.

Against this backdrop, we take a look at some of the indicators of financial health for Australians to help you understand the challenges your customers may be facing at the moment.

Wages growth is flat against expense pressures 

Continuing a long-term trend, wages grew by only 2.08% over the year to December 2017 versus inflation of 1.9% as measured by the Consumer Price Index for the same period.1

In contrast, key household costs have risen. Over the past 20 years, for example, the cost of housing has increased by 330%, electricity by 215% and child care by 310%.2

Consequently, many Australians have struggled to save.  The personal saving ratio continued its decline over the December quarter to 2.7% against a long-term average savings level of 9.87%.3

Debt levels may expose the broader economy to shock

The April 2018 edition of the Reserve Bank’s Financial Stability Review shows that Australia’s level of household debt-to-income ratio is high relative to other advanced economies. The ratio increased by almost 30 per cent over the past five years to almost 190% of net disposable income, after a decade of stability.4

Australia’s high level of household debt increases the risk that some households may experience financial stress in the event of a negative shock. This in turn amplifies any shock to the broader economy. For example, households under financial stress curtail consumption, which the rest of the economy relies on.

Mortgage stress is steady

Total household mortgage debt repayments as a share of income have been broadly steady for several years. However, non-performing loans in states reliant on mining have increased, reflecting increases in unemployment and falling income. 

Some households have faced higher loan costs due to switching from interest-only to principal and interest loans in response to the prudential measures of 2017. To date, households have absorbed these increased costs, helped by low interest rates.

The RBA in its Review observes that, overall, household stress is relatively low by recent historical standards. 

Loan prepayments average around 18%, or are about 2.5 years ahead, creating a buffer. Though, about one-third of mortgages have less than one month’s prepayment, increasing from 16% a decade ago.4 There is a small share of borrowers who have not accumulated prepayments at all despite having had their loan for some time.

Borrowers without a savings buffer either inside or outside their loan would be tested if unemployment or their expenses were to increase. Similarly, if interest rates were to rise.

Fewer interest-only loans now sold but risks remain

The good news is that sales of interest-only loans dropped in the last six months to well-below the 30% benchmark that APRA set last year.5

Despite this improvement, Australia’s legacy book of interest-only loans is of concern. Around 30% of Australia’s outstanding mortgage loans are due to convert from interest-only to principal and interest loans between 2018 and 2021, requiring borrowers to significantly increase their repayments.4

Looking ahead

Most indicators of financial hardship are showing stability, however, savings buffers and loan prepayments are lower than previous averages. One potential shock could be an increase in global interest rates, impacting wholesale funding costs. This would pass through to higher interest rates on loans, which some borrowers may find difficult to absorb. Discretionary spending may take a hit as a result.   

On the positive side is the resilience of the Australian economy to date and the strength and profitability of Australia’s business sector.

Keeping a finger on the pulse

At recoveriescorp, we know how important it is to stay on top of the challenges that may be affecting your customers’ capacity to repay their debts. Over the coming months we aim to publish a set of articles on this topic and the key issues surrounding financial hardship and distress.

⁵ Reserve Bank of Australia Financial Stability Review April 2018

6 Interest-only loans within target: APRA 1 March2018 accessed 15 April 2018