Rising interest rates have put some borrowers in trouble, but the RBA says the banks will be fine & I'm sure that's a relief for the homeless.

The RBA's latest Financial Stability Review (FSR) is under intense scrutiny, with banking failures overseas raising concerns globally, and rising interest rates continuing to put pressure on many households and businesses.

The bank has updated modelling previously undertaken in its last FSR in October about how households are coping with the 3.5 percentage points of interest rate increases imposed by the RBA since May last year.

Given that last year's modelling assumed a cash rate of around 3.5% and the latest model uses a 3.75% cash rate, it is unsurprising that the results remain very similar.

"In the baseline scenario, the share of borrowers with negative spare cash flow – that is, those whose scheduled mortgage repayments and essential living expenses are projected to exceed their household disposable income – would reach around 15% by the end of 2023, with many of these borrowers already projected to be in this position," the RBA noted.

This "baseline scenario" also assumes that unemployment rises only slightly from current levels, that incomes rise by 4.25% and living costs increase 4.75% this year.

Canberra-based public servant Tess (Above) and her family are among those feeling the pressure.

Having been eroded by soaring inflation and big rises in mortgage payments, her part-time wage and her husband's full-time salary are not covering what they used to.

"For us, it's sitting down and saying, 'OK, we're going to not go to the major supermarkets, we're going to cut back on brand-name things, we're going to skip anything that's considered discretionary'," she told The Business.

"And that's tough, especially with little kids."

Despite being a dual-income family on solid pay packets, they have rapidly shifted from being comfortable to feeling like "there isn't really a lot of padding" in their life.

"It's getting to each pay cheque and going: 'OK, pay that bill and pay that bill and how much have we got left?'" Tess explained.

"I don't think I've ever like spent this much time looking at the finances and really saying, 'Can we afford life insurance? Can we afford to go to the dentist?'

"I kind of feel like our income is reasonable. I don't know what's happening to people that are on a lower income – it must be really, really hard for some of those people."

'Adverse scenario':

But things could get even worse.

The bank also modelled an "adverse scenario" where, even though rates remain at 3.75%, unemployment climbs a couple of percentage points to 5.5% by year's end, underemployment also rises 2% and both wages growth and inflation are lower than the baseline forecast, by 0.75 and 1% respectively.

"In the adverse scenario, the share of borrowers experiencing negative spare cash flows by December 2023 would increase slightly to 17 per cent," the bank forecast.

The Reserve Bank has consistently drawn comfort from data showing that more than 60 per cent of all loans had balances in offset and redraw accounts equivalent to more than three months of their scheduled repayments and almost half had buffers equivalent to more than a year.

However, that leaves around 40% of loans with prepayment buffers of less than three months.

The Reserve Bank has again acknowledged that this could leave a substantial group of borrowers who will run out of savings to keep paying their mortgages, even if they slash their discretionary spending.

"Around 9% of borrowers would still be at risk of depleting their savings [by mid-2024], even if they reduced their non-essential spending by relatively extreme amounts (40-80%)," the RBA cautioned.

This proportion increases only slightly to around 10 per cent in the adverse scenario, indicating that it is not necessary for the economy to deteriorate to put many borrowers into serious trouble.

Beyond mid-2024:

Moreover, the Reserve Bank has only considered what happens until the middle of next year, not what would occur if interest rates remain at their current levels, or higher, for a longer period.

"The analysis only considers households' buffers until mid-2024; a prolonged period of high interest rates, inflation or unemployment beyond that horizon would result in more households eventually exhausting their savings buffers," the bank acknowledged.

The bank also revealed that many borrowers will be trapped as "mortgage prisoners" unable to refinance their loans to seek lower interest rates because they no longer meet current serviceability tests at higher interest rates.

"Estimates suggest around 16% of existing loans are unable to meet serviceability assessments conducted at current interest rates."

The RBA emphasised, however, that it believes its estimates around negative cash flows are conservative, with many households having enjoyed larger income increases, having a greater ability to cut expenses and/or having a larger pool of savings outside of their offset and redraw accounts.

On the other hand, the research only looked at variable mortgages, with around 880,000 fixed loans set to come off generally ultra-cheap rates below 2 per cent onto variable rates typically well above 5 per cent over the course of this year.

Betashares chief economist David Bassanese said RBA research into fixed mortgages, published last month, shows they will add 0.7 of a percentage point to the average mortgage rate paid by home loan borrowers over this year and next.

"The wall of expiring fixed-rate mortgages over the coming two years will be equivalent to around one third of the 3.5% increase in the official cash rate already seen over the past year – or around five further 0.25% rate increases, for a cumulative effective official cash rate rise of 1.25 per cent," he noted.

"Given this lagged policy impact, it's little wonder the RBA this week announced a pause in hiking rates."

Original Story By | Michael Janda and Daniel Ziffer