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Home loan arrears are getting worse

Australia’s largest bank, Commonwealth Bank of Australia (ASX: CBA), reported its FY18 result today. This was covered by my colleague Sean O’Neill here.

However, a key section of the reports stuck out to me, the rise in home loan arrears.

According to Commonwealth Bank, the number of home loans that were in arrears by more than 90 days were 0.52% in June 2015, 0.54% in June 2016, 0.60% in June 2017 and 0.70% in June 2018. This is not a good trend!

Principal & interest repayment arrears has been trending higher since December 2017, however interest-only loan arrears have been trending higher since around July 2017. This suggests that the riskiest borrowers are the ones that are facing the most problems.

Commonwealth Bank’s stats also seemed to suggest that whilst the dollar amount of interest-only arrears is slowly increasing, a growing percentage of interest-only loans are in trouble because the total balance of interest-only loans has been reducing since the end of June 2017.

Perhaps unsurprisingly, it is the most recent loans that are the most in arrears. These borrowers will have taken on the largest loans due to the property market hitting its peak. It also means those new borrowers are experiencing the largest increases to their payments with the recent interest rate rises over the past year.

Western Australia and Northern Territory are facing the highest levels of arrears, but all states are seeing more arrears than a few months ago.

Similarly, both owner occupiers and investors are increasingly getting into arrears, it’s not just one or the other.

Why is this happening?

Commonwealth Bank said there were pockets of stress as some households are experiencing rising essential costs and limited income growth.

Another contributor could be the amount of loans that are switching from interest-only to principal repayments.

However, there is a large amount of interest-loans that are on track to switch to principal payments over the next three years. The current house price falls we have seen have occurred before large numbers of these heavily-indebted investors have to face higher repayments.

A lot of them won’t be able to continue into another interest-only loan because of the suggested new 30% limit of loans that can be interest-only as well as the additional serviceability tests that will now be applied. If these tests had been in place all along the housing market probably wouldn’t have performed so strongly and many borrowers may not have actually received a loan.

Hopefully the arrears don’t get much worse, or else we may see continued house price falls for many months to come.

The grossed-up dividend yield of 8.2% for Commonwealth Bank is attractive, however subdued growth will probably persist for a while to come until Australian household balance sheets aren’t so indebted. I personally wouldn’t be buying any shares for a long time.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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