Image – Canva.
  • 45% of CBA's mortgage book has originated since June 2020
  • 20-30% of recent borrowers could face difficulty financing
  • The Housing Expenditure Measure tool is rising well above the target rate of inflation

Newly released research shows that with the cash rate rising dramatically over the past six months, many borrowers are feeling the pinch, albeit with a 2-3 month lag, with many recent borrowers at risk of becoming “mortgage prisoners”.

These borrowers will face difficulty in refinancing or longer qualifying for their loans due to reduced borrowing capacity or/and higher loan-to-value ratios.

The research, from Jarden, revealed that 45% of Commonwealth Bank’s mortgage book was originated since June 2020, with only 10% of the stock of mortgages originated with a cash rate above 3.1%

Across a range of measures, such as borrowing capacity and first home buyer shares, Jarden estimates 20-30% of recent borrowers (10-15% of outstanding mortgages) could face difficulty financing.

“While this analysis is limited by the lack of granular loan level data, similar estimates across a range of measures give us more confidence in the results,” said Carlos Cacho, chief economist of Jarden Group.

“That said, we feel this likely underestimates the true number of “mortgage prisoners”, given the substantial fall in borrowing capacity with 8-9% assessment rates and the imperfect overlap between borrowing capacity and LVR-constrained borrowers.

Carlos Cacho, Jarden Group

“For the banks, we see this as a marginal positive, which may modestly reduce the expected intense mortgage competition, particularly as ~$500bn of fixed-rate loans expires over the years ahead.”

Expenses and buffers to see borrowing capacity fall

Data from the Melbourne Institute’s Household Expenditure Measure (HEM), used by the banks as a floor for expenses, has shown the drives in borrowing capacity over the past two to three years.

Housing Expenditure Measure

housing expenditure measure
Source – Jarden

With inflation at a multi-decade high, increasing expenses are having a larger-than-normal impact. The HEM has increased by about 5%, as of June 2022, with this level expected to continue given inflation is well above the 2-3% target set by the Reserve Bank of Australia (RBA).

Accounting for changes in net income and expenses, Jarden expects borrowing capacity to fall 25-30% by June 2023,  and be down 12-20% versus Dec 2019.

Borrowing Capacity

borrowing capacity fall
Source – Jarden

“This is likely to mean many recent borrowers no longer pass serviceability on their current loans and will face difficulty refinancing unless their income growth has been well above average,” added Mr Cacho.

With data scarce on the distribution of borrowing capacity, data from CBA estimates that 9% of borrowers who have used their full limit.

With a greater than 25% fall in borrowing capacity, those who maxed out their loans will almost certainly become “mortgage prisoners”.

What would happen if there is a 20% fall in house prices?

With the housing correction underway, in which Jarden expects prices to fall by 20%, higher LVRs will likely make refinancing more difficult for some, as borrowers slip above an 80% or 90% LVR.

According to RBA estimates, as at May-22, only 2.7% of mortgages had an LVR > 80% with less than a percent above 90% LVR.

Applying a uniform 20% fall in house price, Jarden estates that 20% of loans would have an LVR above 80% and 9% above 90%.

“Unfortunately many of these exposed borrowers are likely to be first home buyers(FHBs), who generally purchase with lower deposits and higher LVRs, leaving them more exposed to house price falls,” said Mr Cacho.

“Indeed, over the past two years FHBs have represented ~20% of new lending, with recent FHBs representing ~8% of outstanding credit. We expect some of these FHBs, particularly those who entered the market near the peak and with low deposits (i.e. FHLDS borrowers with 5% deposits), will be most at risk of becoming mortgage prisoners.”

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