Budgets squeezed by Inflation


The Australian household budgets are experiencing strains due to the impact of higher interest rates and inflation, leading to an increase in expenses for renting and mortgaged households. The limited savings and lower spare cash flows of lower income households, including renters and recent borrowers such as first home buyers, are particularly affected. This has resulted in reduced growth in consumption and saving, with consumer spending being cut back and the household saving rate declining. Notably, consumer sentiment, especially among those with mortgages, is at historically low levels.

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Higher scheduled mortgage payments are a significant factor in declining spare cash flow for households with mortgage debt. Borrowers with variable-rate loans have experienced substantial increases in their loan payments, while those with fixed-rate loans will face large increases in payments when their fixed rate expires in 2023 and 2024. This is expected to further intensify pressures on household budgets as cash rate increases continue to pass through to variable-rate borrowers, and fixed-rate loans transition to higher variable rates. Total scheduled interest and principal payments are projected to reach around 9¾ percent of household disposable income by the end of 2024, adding further strain on household budgets.

Although most borrowers have been able to manage their debts by adjusting their spending and saving habits, there has been a slight increase in early-stage mortgage balance rates, possibly due to seasonal effects. Community groups have reported increased demand for assistance with debt obligations, and low-income mortgagors, particularly those in the bottom quartile of incomes, are devoting a larger share of their income to servicing their housing loans. In contrast, borrowers in the highest income quartile spend a smaller share of their income on essential living expenses and are better able to meet larger debt-servicing costs.

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Despite these challenges, households in Australia remain in a strong financial position, with household assets remaining 25 percent higher than at the end of 2019, just prior to the pandemic. However, there has been a decline in the rate of savings growth compared to previous years, and borrowers have been using their mortgage prepayment buffers to cover regular expenses rather than discretionary expenses. The strong labor market in Australia has supported household finances, with growth in nominal incomes allowing households across different income levels to add to their offset and redraw account balances, particularly those with lower and middle incomes.

Borrowers with low liquidity buffers are at higher risk of facing challenges in servicing their debts, especially if they also have high debt levels and low incomes. Approximately 40 percent of loans have less than three months of prepayment buffer, putting these borrowers at risk of struggling to meet their loan obligations in case of income or expense shocks. Loans with low buffers that were extended to owner-occupiers at very low variable rates between March 2020 and April 2022 are considered potentially riskier, as borrowers’ scheduled payments are likely to be close to or above the maximum level assessed by their lender at the time of origination, and these borrowers are less likely to hold savings outside their mortgages compared to comparable fixed-rate borrowers. Older loans also pose higher risks, as they may reflect borrowers who consistently have little spare cash flow to save.

Low-income households have less ability to draw on wealth or reduce discretionary consumption to free up cash flow for debt servicing. Most variable-rate owner-occupier loans with fewer than three months of prepayments and a loan balance that is more than six times the borrowers’ annual income are held by low-income borrowers. However, despite these risks, as of early 2023, more than 60 percent of all loans still had balances in offset and redraw accounts that could cover more than three months of their scheduled payments, indicating a high level of resilience to rising interest rates and increased costs of living.

In conclusion, although Australian household budgets are facing pressures from higher interest rates and inflation, most borrowers have been able to manage their debts as interest rates and living costs continue to rise.


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