Sydney mortgage broker Luke Gardiner, who started his business just last year, is already overwhelmed with customers.
“There has not been a slow period in the last 12 months,” said the broker, whose Gardiner Financial Services Pty arranged more than A$5 million ($4.5 million) in mortgages in both June and July, about A$1 million more than in May. “I’ve been waiting for a break, but it hasn’t come.”
Driving the growth is demand for high-risk mortgages such as interest-only loans and financing to buy rental properties. That’s setting the stage for a jump in mortgage delinquencies when interest rates increase from record lows, Moody’s Investors Service said this month. The easier terms are fueling housing demand, boosting prices 11 percent in major cities in August from a year earlier.
“There has been an advent of higher-risk lending,” said Nader Naeimi, head of dynamic asset allocation at Sydney-based AMP Capital Investors Ltd., which manages about A$144 billion. The regulator “hasn’t been able to curb it.”
The Australian Prudential Regulation Authority in May warned of growing evidence of “lending with higher risk characteristics.” It issued draft guidelines urging lenders to assess whether borrowers were capable of repaying mortgages at higher interest rates. It also asked banks to conduct regular stress tests on its loan books to determine the impact of rising unemployment, interest rates and falling property prices.
Interest-only mortgages jumped to 43 percent of all new home lending in the three months through June 30, and credit to buy rental properties climbed to 38 percent, both record highs, according to APRA data starting in the first quarter of 2008.
“The higher proportion of investment and interest-only lending suggests that APRA’s efforts have not slowed a broad increase in higher-risk exposures,” Ilya Serov, senior credit officer at Moody’s, wrote in a Sept. 1 report.
Spokesmen for the country’s four-biggest lenders -- Australia & New Zealand Banking Group Ltd. (ANZ), National Australia Bank Ltd. (NAB), Commonwealth Bank of Australia and Westpac Banking Corp. (WBC) -- said their mortgage approval processes took into account customers’ ability to repay at higher interest rates.
Borrowers are flocking to Australia’s A$1.4 trillion mortgage market, lured by some of the cheapest loans ever. Outstanding mortgages climbed 6.5 percent in the 12 months through July, the fastest pace since February 2011, according to data from the Reserve Bank of Australia.
Five-year fixed rates at the four-largest lenders are at 4.99 percent, historical lows. Discounts on variable rate loans of as much as 1.4 percentage points are also the highest on record, according to data from broker Mortgage Choice Ltd., which helps arrange A$1 billion of home loans a month. About 85 percent of mortgages to owners who occupy homes are on variable rates, according to the Australian statistics bureau.
Cheap money is driving prices higher. Property agent Darren Dowd last month sold a three-bedroom house in the northwestern Sydney suburb of Baulkham Hills for A$895,000, almost A$100,000 more than he expected, in an auction with 12 bidders. Two years ago, he sold the same house, about 30 kilometers (19 miles) from Sydney’s central business district, for A$605,000.
“Prices in our area have increased about a quarter of a million dollars just in the past couple of years,” said Dowd of broker Ray White Baulkham Hills, adding that the number of people choosing to sell their homes at auction is at a 15-year high. “We’ve seen a sharp increase in auctions in just the past three months because people are seeing the exceptional results others are getting and saying, ‘I want what he has.’”
Martin North, Sydney-based principal at researcher Digital Finance Analytics, said inexpensive mortgages have emboldened households to take bigger loans that they may have trouble repaying.
“There’s no doubt the low rates have got many borrowers out of jail,” he said.
A 2 percentage point rise in interest rates would put more than 25 percent of households in mortgage stress within 12 months, he said. They would need to cut other expenses and increase credit card debt to keep up with repayments.
“It’s parallel to what happened in the U.S. before the global crisis,” when easy credit to high-risk borrowers inflated a housing bubble that burst, creating a wave of defaults.
Loans to investors accounted for 33.8 percent of all mortgages in the three months through June, the highest level since March 2009, APRA figures show. Outstanding interest-only loans -- where borrowers can postpone repayment of the principal for a set number of years -- increased to 35 percent, the highest since APRA began reporting the data.
“For those borrowers who’ve taken out interest-only loans, there’s always a prepayment shock when the interest-only period ends,” said Serov at Moody’s, which forecasts rates will rise over the next 18 months. “In a rising rate environment, that repayment shock is greater and delinquency rates for those loans would be greater.”
Australian housing is a “significant” source of risk to the financial system as household leverage has almost doubled since 1997, a government inquiry in July found. Australians owed almost 1.8 times their 2013 pretax disposable incomes, higher than Canada, France, Germany, Italy, Japan, U.K. and the U.S., the nation’s statistics bureau said in June. Household debt was equivalent to A$79,000 per person at the end of 2013 and has risen at almost double the pace of assets over the past 25 years, it said.
The central bank’s record-low benchmark rate has remained at 2.5 percent for 13 months. The RBA lowered borrowing costs from late 2011 to August 2013 in part to boost housing construction and consumption after the end of the mining boom spurred a rise in unemployment.
Even as the jobless rate reached a 12-year high of 6.4 percent in July, RBA Governor Glenn Stevens has refrained from further rate cuts. The unemployment rate fell to 6.1 percent in August, drawing skepticism from economists at NAB, ANZ and Morgan Stanley who expect the number of jobs added to be revised downward.
“We don’t want to foster too much build-up of risk in the financial sector, such that people are overextended,” Stevens said on Sept. 3. “The more prudent approach is to try to avoid, so far as we can, that particular boom-bust cycle.”
Banks have heeded APRA’s warnings in at least one area. The proportion of mortgages for more than 80 percent of a property’s value fell about 1 percentage point to 33.8 percent in the three months through June from the previous quarter, the regulator’s figures show.
“Banks have been tightening up in some areas, like loan to value ratios,” Gardiner, the broker, said. “But they have become more flexible with other products and product features.”
The non-performing share of banks’ domestic housing loan portfolios dropped to 0.6 percent in the six months through December 2013, according to central bank data. The share is down from its mid-2011 peak of 0.9 percent, aided partly by low interest rates, the central bank said in its latest Financial Stability Review.
“As long as rates remain low, the masking will continue, and more households will overcommit,” North at Digital Finance Analytics said. When they rise, “the chickens will come home to roost.”