Thank you to the Property Council for asking me to speak at this Property Leaders' Summit. I want to address an important issue for the property industry – the rising rate of housing loan arrears (Graph 1). Why is it that an increasing share of housing borrowers are behind in their mortgage repayments? Mortgage arrears can be associated with significant personal trauma for borrowers. They also point to a rising risk to the financial system as housing loans are 40 per cent of banks' assets. If the value of the property backing the loan exceeds the value of the loan then arrears won't have a big impact on banks' profits or capital. But with falling housing prices the potential for banks to experience losses increases. So, on several fronts, this is an important issue.
There are many reasons why borrowers fall into arrears, almost all of which involve a fall in income or rise in expenses – or both. Some borrowers experience personal misfortune, such as ill health or a relationship breakdown, which is unrelated to economic conditions or the quality of their loan. And even in good times, some people become unemployed. So there will always be some borrowers who fall into arrears.
However, it is weak economic conditions that drive cyclical upswings in arrears. In particular, borrowers can struggle to make their payments if their income falls. Weak conditions in housing markets make it hard for borrowers to get out of arrears by selling their property. Conversely, large increases in interest rates, say to slow an overheating economy, can also contribute to rising arrears.
Banks' lending standards also play a role in arrears. And it is important to note that economic conditions and lending standards interact. Poorer quality loans might continue to perform well in good economic conditions, and only fall into arrears with an economic downturn. In contrast, good quality loans will be more resilient in a downturn.