Borrowers today are faced with the full extent of the RBA’s rate rises, cost-of-living pressures and higher inflation, which has seen mortgage arrears and delinquencies starting to rise. But hope is not lost for borrowers who might require additional support; brokers and lenders are stepping in to save the day. We take a look at the specialist lending space and the ways brokers and lenders are jumping in to the rescue
It’s been a turbulent time for borrowers over the past year. Persistently high inflation has led the central bank to hike up the cash rate by 1.5 per cent in the past 12 months alone – pushing up borrower repayments by an eye-watering amount (particularly for those with a high debt burden).
In fact, the Reserve Bank of Australia’s (RBA) half-yearly Stability Review, released in October, revealed that payments on variable rate loans had increased by between 30 and 50 per cent, depending on when the loan was originated, and that 10 per cent of borrowers who had rolled off fixed rates since May 2022 have seen repayments rise by more than 60 per cent, with another 14 per cent expected to join them.
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About 1.5 per cent of borrowers are estimated to have their essential expenses and mortgage costs exceed their income and be at high risk of depleting any available buffers.
The RBA Stability Review estimated that, in July 2023, between 5 and 13 per cent of variable-rate owner-occupiers were paying more on their essential expenses and mortgage costs than they received in income.
Moreover, about 30 per cent of the estimated 5 per cent of borrowers with insufficient income (using the baseline HEM) were found to be at risk of depleting their buffers within six months – and so are at higher risk of falling into arrears on their housing loan.
Lower income borrowers are generally “over-represented” in these groups as they are more likely to have difficulties covering their essential costs and mortgage payments and lower savings buffers.
Indeed, up to 50 per cent of borrowers with a high loan-to-income (LTI) ratio might not have the necessary income to cover housing costs and necessary expenses and around 7 per cent of fixed-rate owner-occupier borrowers have larger costs than income after rolling off their fixed rates.
However, the central bank noted that the majority of borrowers have successfully made adjustments to their finance, where needed, and stated that the cohort of borrowers at higher risk of falling into arrears on their mortgage “remains small”.
In the report, it commented: “While almost all borrowers have been able to make adjustments that have allowed them to continue servicing their debts and cover essential spending, the share falling behind on their mortgage payments has begun to pick up from a low level.
“Borrowers with low incomes, large loans relative to their income or property value, and low savings are particularly at risk.”
Arrears on the rise
As expected, arrears have been rising. The RBA found that arrears rates for borrowers who have transitioned from fixed to variable rates are higher for owner-occupiers than investors at approximately 0.75 per cent versus 0.30 per cent.
According Fitch Ratings’ Mortgage Market Index – Australia: The Dinkum RMBS Index 2Q23 report, Australia’s 30-plus day mortgage arrears rate rose by 9 bps to 1.07 per cent in the second quarter of 2023.
While the arrears rate has been coming off the lowest levels seen in over two decades (given the built-up savings, improved job mobility brought on by strong growth in employment and strong refinancing conditions), the agency warned that the cash rate hikes over the last 18 months are likely to continue to drive mortgage arrears up further in 2023 and beyond.
The report warned that mortgages written between 2019 and 2021 (when the serviceability buffer sat at 2.5 per cent) were “more susceptible to deterioration in performance, as the cash rate is now above this buffer”.
Meanwhile, 90-plus day arrears rate rose 7 bps in 2Q23, up to 0.53 per cent, with Fitch stating that late-stage arrears are expected to rise as the year draws to a close given that borrowers are facing servicing pressure from climbing interest rates.
Similarly, Moody’s Investor Services recently found that the share of prime quality home loans in residential mortgage-backed securities (RMBS) that were at least a month behind schedule rose to 1.38 per cent in June 2023, up from 1.25 per cent recorded in March.
Non-conforming mortgages recorded a delinquency rate of 3.98 per cent in June, up from 3.84 per cent in March.
Meanwhile, credit ratings agency S&P Global Ratings (S&P) believes that the peak in arrears will come in 2024, as the lags in transmission of the RBA’s rate hikes begin to dissipate.
What do these borrowers look like?
With arrears and delinquencies ticking up, more borrowers will find that their credit scores have been affected and that they’re no longer classified as a prime borrower. And a growing cohort of borrowers are falling into this category.
Speaking to The Adviser, Mortgage Choice Springwood broker Dean Naylor said that in his experience, it has been typical “mum and dad households” that have been falling into the near prime or specialist segment recently.
“Unfortunately, it’s your everyday people getting hurt the most. These are borrowers that took advantage of when interest rates were low to buy a larger house to suit a bigger family, but once their rates went up from around 2 per cent to 6 per cent, the stress starts to set in,” Mr Naylor stated.
“In some cases, these borrowers will have no choice but to sell, but in others they tend to reassess their situation and restructure everything.”
He suggested that some borrowers were falling into the near-prime category as they hadn’t yet adjusted their spending behaviours in sync with rising costs.
“Consumer spending only started to really slow down in recent months. There’s been households in Australia that were still spending as if interest rates were still at 2 per cent,” he said.
While lenders look at a range of criteria when assessing the risk profile of a borrower – anyone with a credit score of less than 630 is generally considered to be a near-prime or specialist borrower.
Different lenders will have different definitions for what they consider to be a near-prime or specialist borrower, but many will provide flexible options. As such, brokers are playing a key role in helping borrowers find solutions for when they think they’ve got no options.
Mr Naylor explained: “First of all, there’s a couple of lenders who don’t actually take poor credit history too far into account.
“If a borrower can still string together two or three months of good conduct over six months, they can go to a couple of lenders who only go off negative data or maybe only take one or two defaults into accounts.
“It’s not like these borrowers have no options upfront. If you do have poor credit, it just comes down to finding a lender that will still accept you based on your circumstances.”
Indeed, the RBA noted in its Stability Review that “households often contact their lender to inquire about options to restructure their loan or apply for temporary hardship”, adding that payment deferrals can be an option.
Some lenders may still offer near-prime borrowers the same rates as prime borrowers in order to help them navigate, and possibly improve, their new-found credit position.
“If their credit situation is very poor, we tend to refer these people to a non-bank lender, such as Liberty, Bluestone or Pepper Money, with the active strategy that they’re going to spend six months to a year with that lender on lower mortgage repayments to get their credit back on track while still maintaining any equity they’ve earned,” Mr Naylor explained.
Non-bank lenders such as Pepper Money have a range of products aimed at assisting borrowers falling out of mainstream serviceability – with the lender winning the broker’s choice award for specialist loans in the Non-Bank Product of Choice ranking earlier this year (see the June edition of The Adviser magazine for more).
When asked what brokers can do to help these borrowers, Mr Naylor emphasised the importance of fixing their credit situation and “show them the light at the end of the tunnel”.
“When you tell someone that their only option is a lender that’s going to charge 2 per cent above market, they’re not going to want to hear that,” Mr Naylor said.
“You have to set them aside and tell them the situation they’re in and what they need to do to move themselves back into the prime lending space.
“I think having that longer-term clarity does help a lot of clients.”
Helen Avis, broker at Specialist Mortgage, agreed that while providing hope was key to helping specialist borrowers, so was empathy.
She said: “First and foremost, it’s essential to foster open and empathetic communication with clients. When clients express their financial struggles, it’s a sign they trust us and see us as a valuable resource. Listening attentively to their concerns is the first step in offering support.
“Brokers can often be the initial point of contact for clients grappling with financial difficulties. Clients typically approach brokers with concerns about rising repayments and the challenges they face in meeting them … Validating their concerns helps build trust and creates a safe space for honest discussions. To provide the best guidance, it’s crucial to review their financial situation thoroughly and trust plays a big part in this.”
