Fitch Ratings has noticed a significant rise in mortgage arrears in Australia during the first quarter of 2025. This spike is mainly due to ongoing cost-of-living pressures and high interest rates affecting household finances. Conforming mortgage arrears (loans overdue by 30 days or more) increased by 0.23% to 1.36%. Non-conforming arrears rose by 0.39% to 5.32%. This increase is nearly three times the usual seasonal rise of about 0.08% in the first quarter. The combination of high interest rates and continuing inflation has driven this increase. Although the RBA cut rates in February and May, the benefits of these cuts weren’t visible in the first quarter data. Housing prices also bounced back with a 0.9% increase after dropping in late 2024. Fitch expects prices to continue rising in 2025 due to limited housing supply, lower interest rates, and strong migration. To manage potential losses from mortgage defaults, Fitch Ratings has changed Australia’s outlook from stable to negative while keeping its current rating. This data clearly shows that mortgage arrears in Australia have risen substantially more than expected. Typically, we see a slight rise at the beginning of the year due to post-holiday spending pressures. However, this data indicates that these temporary issues have evolved into deeper financial challenges. Standard loan arrears have surged, which is unusual. Riskier loans are seeing even greater difficulties since their borrowers have less flexibility with high rates. When interest rates stay elevated, we can anticipate some problems. Coupled with persistent inflation, the strain is evident in this data. It’s important to note that these arrears increased even before recent rate cuts could impact them. While the rate reductions in February and May could provide some relief, the effects will take time to materialize. We likely won’t see significant changes until later this year, and financial stress continues to grow in the meantime. Housing prices are picking up again after a brief drop. Rising prices can help borrowers struggling to make repayments. A borrower with equity in their home is less likely to default if they can sell or refinance. However, timing is a challenge. The support from equity may not be quick enough for households falling behind. Also, since the price increase is partially due to limited supply rather than strong demand, it’s not a complete solution. The credit ratings landscape is responding. Moving from a stable to a negative outlook signals a warning. While the current rating remains the same, the underlying support is weakening. High arrears and sensitivity to interest rates cannot be overlooked. If conditions worsen, the calls for a reassessment will become louder. From our perspective, this has clear implications. Risk pricing must change to reflect delinquencies that are not just seasonal hiccups. Credit performance is shifting. If we continue to rely on last year’s models, we risk underestimating true exposure. We need to recognize that borrower stress is lasting longer than initially expected, especially in more vulnerable asset pools. Volatility linked to interest rate predictions will stay high as markets try to gauge when and how much monetary easing will happen. Even small cuts in policy rates may not immediately ease arrears. Borrowers adapt slowly, not instantaneously. Additionally, ongoing high costs for rent, utilities, and food are tightening the discretionary budgets that households rely on to stay current on payments. For mortgage-linked instruments, past performance is no longer a reliable guide. We need to prioritize forward-looking metrics, such as wage growth and unemployment expectations, particularly when making adjustments to manage risk. The same applies to interest rate curves that are flattening based on optimism that remains, for now, unproven. Moreover, short-term growth in housing prices might lead some models to underestimate the chance of defaults. A small increase in prices does not equate to strong consumer confidence, especially when driven by supply shortages and migration. These price hikes offer little comfort to borrowers still struggling to keep up with repayments. We should not assume that historical trends will repeat themselves perfectly. Risk buffers and stress tests need continual adjustment. We should expect volatility in arrears to persist through midyear until we see clearer signs of recovery in disposable income – which we have not seen yet. When making decisions based on assumptions about borrower behavior, it’s essential to be cautious. Models that fail to account for the transition from liquidity issues to actual loan deterioration risk missing crucial outcomes.

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