Australian borrowers are a fortunate bunch. Unlike households overseas, they’ve managed to avoid the wave of painful mortgage defaults that have brought other economies to their knees.
Indeed, local banks say the share of people falling behind on their mortgage payments is at historic lows.
Yet history suggests things will not stay like this forever. Bad housing loans will increase one day, and bankers say that many of the loans that will go bad are probably being written now, when interest rates are so low.
So, which borrowers are most likely to fall behind on their mortgage payments?
The Reserve Bank recently published some useful information on who is at most risk of falling more than 90 days behind on their mortgage. The findings are worth keeping in mind, especially if you’re someone who might be at higher risk.
The RBA concluded that the size of the debt you are taking on makes a big difference, especially the proportion of the property purchase funded with borrowed money. This is known as the loan-to-valuation ratio (LVR).
If you take out a loan with an LVR of 90 per cent or more, the likelihood of missing a payment is three and a half times greater than for a loan with an LVR of 60 per cent or less, and almost twice as great as for loans with LVRs of 80 per cent to 90 per cent.
That’s why banks generally force anyone with an LVR of 80 per cent or more to take out mortgage insurance – something that can add thousands of dollars to the cost of a loan.
The important thing to remember is that mortgage insurance protects the bank from default, not the borrower.
But it’s not only the loan size that matters – there are other potential risks to be aware of.
Borrowers who pay higher interest rates are also more likely to fall behind. If there are two identical loans and one has an interest rate that is 1 percentage point higher, that borrower is about 1.4 times more likely to fall behind, the RBA said.
People who always pay off their credit card in full each month are also less likely to fall behind on their mortgage.
And low-documentation loans – where the bank does less checking of the borrower’s financial situation – are more likely to go bad.
What’s the bottom line, then?
For one, size matters a great deal with a loan. It’s important not to borrow more than you can comfortably service, especially as interest rates will inevitably rise one day.
The research also suggest that it’s worth being extra cautious with your mortgage payments if you are someone who has a high LVR loan, has a low-doc loan or has let their credit card debt pile up.